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U,   H"z ??`0   z .*Ron D Vari, Ph.D., CFA("     Ht"z ??`` 0 z E*(N  6޽h ? ffMMM̙̙   6.0 (  ^B  6dp  BDz? ??@` . T Click to edit Master Title Style! !  Tz?  p)p??@`  . W#Click to edit Master subtitle style$ $R  s *R  s *   Hdz ??` . C*    HĬz ??`0   . E*(   H$z ??`0  . E*(N  6޽h ? ffMMM̙̙ 0 ~vP (    <z ??P!  . E*  ^   S  ?*  ."   <Dz ?? @ . RClick to edit Master text styles Second level Third level Fourth level Fifth level!     S   <z ?? ! . G*(    Bz ??vP  . E*     Bdz ??v  . G*( B  s *޽h/. ? ̙33 @{(    <z ??P!  . @ Ron D'Vari     <dz ?? ! . E*(   B$z ??vP  . ETitle goes here    Bz ??v  . E*( B  s *޽h/. ? ̙33  $ B: (    3 rzgֳgֳ ?@` .   3 rzgֳgֳ ?`  . N  6ffd޽h ?  >, *State Street Research xppl(  lx l c $.@` .  l <.??0pJ "&Transactions Most Actively Considered: Asset Swap Total Return and Index Swap Default Swap Other Credit Derivative Structures Under Consideration: Credit Linked Notes (CLNs) Credit Spread Option CBOs, CLOs, Synthetic CLOs Synthetic Leveraged Loan Synthetic Revolving Credit Agreements( 27 28 2 2&77P C l # lT.1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B l s *޽h ? ffMMM̙̙ >, *State Street Research (    # l.1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1   ND% ??@` .   <%??0p t Flexible Credit/Sector Exposure Tailoring Access: Sourcing names and maturities not available through cash instrument market Flexibility: Uncoupling of interest and credit exposure Diversification Yield Enhancement Exposure to short maturities with low price sensitivity Relative Value and Replication Cheaper synthetic cash positions Hedging Leverage or Financing + 2  % 28    2!    2 2+%8 !!jB  s *޽h ? ffMMM̙̙k >, *State Street Research  k(   ~   s *d&0 z 3   <&??`  Internal and External Education Accurate Portfolio Analytics and Risk Models Consistent Framework for Use In Portfolio Context Infrastructure: Compliance, Trading, and Accounting Systems Signing ISDA Agreements Several hundred plan sponsors and separate accounts Multiple dealers and banks A dozen custodians Legal resources Shortcomings of the Standard Representations in ISDA Not developed for investment managers acting as agent Often impossible for managers to make Requires involvement of plan sponsors and custodians% 2s  25% 2  2s59i?r   # l$'1??  State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @B   s *޽h ? ffMMM̙̙:  >, *State Street Research   T: (  T~ T s *'@`   T <D(??` ^Besides fundamental analysis of reference credit and counterparty overall portfolio suitability has to be established. Optimal allotment of risk budget to credit derivatives Portfolio s total risk is budgeted to key active exposures Level and shape of term structure of interest rates Volatility Sector/Credit exposures (by sector by credit by maturity) Risk Analysis and Its Transparency Accurate accounting of credit derivatives in daily and intraday portfolios multi-factor absolute and relative risk reports Measure credit, spread change, and structural risks Quantitative Relative Value Framework W.r.t. cash instruments or other forms of risk Liquidity and Pricing Infrastructure 2; y4$ 2 & 2/ % 2;x$&/%9i?r T # l(1??  State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @B T s *޽h ? ffMMM̙̙Q >, *State Street Research Q(  ~  s *d)@`    <)??` YDocumentation Trading Counterparty Risk Management Compliance Accounting and Custodial  Z% 2Z9i?r  # l$*1??  State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @B  s *޽h ? ffMMM̙̙ >, *State Street Research XP0( `G10 0~ 0 s **@`   0 <D+??`v JDLimited Recourse Sub-account managed by manager Size Matters No trigger with account size change May require lower collateral threshold and minimum transfer Collateralization Eligibility Threshold and minimum transfer amount Manager Termination Avoid early termination through assignment Assignment Both parties consent % 2  2 % 2b  2% 22  2% 2+  2 % 2  2  2  2 S2 C9i?r 0 # l+1??  State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @B 0 s *޽h ? ffMMM̙̙9 >, *State Street Research 0L9(  L~ L s *d,@` z  L <,?? GChanges in Credit Condition Credit Spreads in Cash Market Cost of Alternatives Regulatory Capital Requirements General Market Liquidity Pricing Models Traditional Credit Judgment Quality of Historical Default Rates and Recoveries Availability and Quality of Historical Spread Availability of Volatility and Correlation data Credit Default Swap Curves Basis Between Credit Swap and Other Credit Pools Modeling Tranched Credit and Basket@ 2  2 8? L # l$-1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B L s *޽h ? ffMMM̙̙ >, *State Street Research P@(  @~ @ s *D.@`  / @ <.??0p[ GPresentation Focus: Asset Swap Total Return and Index Swap Default SwapJ 24 2 )8? @ # l/1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B @ s *޽h ? ffMMM̙̙    ptH (  XE tx t c $$0@`  \ t <0??  t Motivation Swap floating assets to fixed or vice versa Trade away imbedded options in a bond or layer in options R 2h 2 i t # l01 ?? JSSRM*( t # lt)1 ??`0p S Counter Party*( B t 3 rDԔ??  B t@ S ~?DԔ?? t 3 r4*1??4  HCoupon from Bond A   t 3 r*1??@` x2Some Index (Libor, CMT, fixed level etc.) + Spread*3(2  t # l*1 ??  LBond A*(B  t S ~?DԔ??00B  t S ~?DԔ??  t  f+1??0` XCoupon and Principle(  t  ft,1??0v C Market Price  t # l,1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B t s *޽h ? ffMMM̙̙  H@| (  |x | c $-@`   | <-?? P  K Motivation Adjust exposure without buying or selling individual securities Hedging, Relative Value, Market access, Flexibility Avoid paying bid-ask spread for a short dated trade Get financing (leverage) R 2 2  | # lT.1 ?? JSSRM*( | # l/1 ??`0p S Counter Party*( B | 3 rDԔ??  B |@ S ~?DԔ?? | 3 r/1??0`  OIndex Sector Total Return   | 3 r401??@B v0Libor + Spread or Total Return of Another Sector*1(0  | # l01 ??  _SSRM Holdings in a Sector*(B  | S ~?DԔ??p00B  | S ~?DԔ??  |  f11??`, YHoldings Total Return(  |  ft21?? e Market Price  | # l21??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B | s *޽h ? ffMMM̙̙   bZ(  x  c $3@   x  c $3?@@    # lT41??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B  s *޽h ? ffMMM̙̙   \T( Q C x  c $$u   r  S u``     # lu1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1 B  s *޽h ? ffMMM̙̙   H (  Hx H c $v`@   x H c $w?@@   H # ldw1??  $State Street Research & Management, Ron D Vari, Ph.D., CFA * (D C @F1  H Bw  p)p? 0 : ? H B$x  p)p?p mMethod 1: Basis - Asset Swap vs. Default Swap (works only for single name) Method 2: Model Loss Distribution "mnO% 8 @ H   H  fx1 ?? P o%Market Implied Default Probabilities.&(%B H 3 rD8c??    @ PpP H@ H  fy1 ??@  XCredit Spreads.(  H  fdz1 ??p XRecovery Rates.(  H  f${1 ??P  \Asset Correlations.(  H  f{1 ??P P  ^Default Correlations.(B  H S ~?D8c??P P B HB S ~?D8c??P `B H S ~?D8c??P B HB 3 rD8c??P` 2 H # l|1 ?? @ E Simulator (  H  fd}1 ?? P [Loss Distribution.(B H 3 rD8c?? p B HB S ~?D8c?? P B H S ~?D8c??B H s *޽h ? ffMMM̙̙>      ~ (  r  S $~@   r  S ~@  L  N N #   6D1111? 4 M O ACCOUNT*    ZB  s *?J g9   B1111?$4  Z$Default Option on $10mm TCI 7 6/99%%   6*1111?d90 N d COUNTER-PARTY:   ZB  B s *?Jg9   B+1111?$3 A 40BP/Annum       6,1111?t9M N ;AAA Asset Back Maturing 6/15/99 (+20 to 25bp over Treasury)*<;  ZB   s *?t9ZB   s *?t9  Bd,1111? '\- :Bond   B,1111? 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