Sample Swap Agreement

							                               Municipal Debt Advisory Commission
                                Sample Interest Rate Swap Policy
                                         (Adopted February 5, 2004)


Introduction

The purpose of the Swap Policy is to establish guidelines for the execution and management of the
District’s swap (interest rate exchange) program. This Swap Policy confirms the commitment of the
Board, management, staff, advisors, and other decision makers to adhere to sound financial and risk
management practices, including achieving the lowest possible cost of capital within prudent risk
parameters. It is expected that this Policy will be reviewed at least annually and updated as necessary.

Philosophy Regarding Use of Swaps

Interest rate swaps can be appropriate interest rate management tools. Properly used, swaps can
increase the District's financial flexibility and provide opportunities for interest rate savings, enhanced
investment yields, or reduced risks. Swaps should be integrated into the District's overall debt and
investment management policy.

Swaps will not be used for speculation. For policy purposes, speculation means taking additional risks,
unrelated to the District’s business, in an effort to increase returns. The District will follow rules simliar to
those they would use on any significant investment.

Swaps may be used when they achieve a specific objective consistent with the District’s overall financial
policy. Swaps may be used, for example, to lock-in a current market fixed rate or create additional
variable rate exposure. Swaps may be used to produce interest rate savings or alter the pattern of debt
service payments. Swaps may be used to cap, limit, or hedge variable rate payments.

Reasons to use Interest Rate Swaps and Swaptions include, but are not limited to:

    •   Reducing interest expense;
    •   Hedging and actively managing interest rate, tax, basis, and other risks;
    •   Optimizing capital structure (e.g., achieve targeted debt allocation);
    •   Achieving appropriate asset/liability match; and
    •   Enhancing investment returns.

Permitted Instruments

The District may use the following financial products after identifying the specific financial objective to be
realized and assessing the attendant risks:

    •   Interest Rate Swaps -- Immediate or forward starting floating-to-fixed rate swaps may be used to
        capture current market fixed interest rates or eliminate variable rate exposure. Fixed-to-floating
        rate swaps may be used to create additional variable interest rate exposure.
    •   Interest Rate Caps -- Financial contracts (caps, collars, floors) may be used to limit or bound
        exposure to interest rate volatility.
    •   Options on Swaps –- Sales or purchases of options may be used to commence or cancel interest
        rate swaps. Options can range from simple (e.g., European or American) to exotic (e.g., knock-
        outs).
    •   Basis Swaps -- Floating-to-floating rate swaps may be used to manage basis or tax risk and
        change the basis on which variable cash flows are determined.
    •   Rate Locks –- These are often based on interest rate swaps and may be used to hedge an
        upcoming fixed rate bond issue.



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    •   Structured Notes -- Fixed income securities may be used to offer investors a tailored risk/reward
        pay-off. The District may execute hedging agreements to return to a fixed or variable rate.
    •   Total Return Swaps – These may be used to manage credit and market risk of securities.
    •   Other financial products – May be used at the discretion of the Board.

The District should use interest rate exchange (swap) financial products to produce a result not otherwise
available in the cash market (lack of advance refunding/non-callable debt) or provide a higher level of
savings, lower level of risk, greater flexibility, or other direct benefits related to the debt obligation with
which the swap product is associated.

The District may not use interest rate exchange financial products that (i) create extraordinary leverage or
financial risk; (ii) lack adequate liquidity to terminate at market; or (iii) provide insufficient price
transparency to allow reasonable valuation.

Swap Risk Analysis

The District shall evaluate all derivative financial products with respect to the unique risks with which they
are associated. A specific determination must be made that the expected benefits exceed the identified
risks by an adequate margin over those available in the traditional cash market, if any.

    •   The District shall evaluate the potential risk involved for each transaction by examining all of the
        factors listed below; such evaluation shall also include an analysis of the impact of the risk
        attendant to the proposed swap transaction on the District’s overall financial assets and liabilities.
        The District shall examine:Market or interest rate risk - Does the transaction hedge or create
        interest rate volatility? By how much?
    •   Tax Risk - Is the transaction subject to a future change in federal income tax policy?
    •   Termination Risk - Under what circumstances might the transaction be terminated? What is the
        probable range of values? How would a possible termination payment be funded?
    •   Risk of Uncommitted Funding (Put Risk) - Does the transaction entail the risk of future
        refinancing needs?
    •   Legal Risk - Is the District authorized by its governing law to enter into the transaction and has it
        received the required authorization, if any, from its governing body or authority?
    •   Counterparty Risk - What is the creditworthiness of the counterparty?
    •   Rating Risk - Is the proposed transaction consistent with current ratings of the District’s financial
        obligations?
    •   Basis Risk - Do the anticipated payments the District will receive match the payments it makes? If
        not, is the basis risk justified by the expected benefits?
    •   Subsequent Business Conditions - Does the transaction or its benefits depend upon the
        continuation, or realization, of specific industry business conditions?

Risk Limits

Value at Risk. This District shall measure, monitor, and limit its market risk on interest rate swaps. The
District will calculate the effect of a 1% unfavorable change in interest rates on its swap program at least
quarterly. The aggregate Value at Risk of the District’s swaps will be limited to ___% of total
[investments/debt] or $___ million.

Other limits. Swap terms may not exceed the term of the debt obligation associated with the swap
(interest rate exchange) agreement. The total notional amount of the swap agreement must not exceed
the total par amount of the debt obligation association with the swap agreement.

Financial Advisor, Swap Procurement and Execution

The District will retain an independent financial advisory firm (FA) to assist it on all matters related to
procuring, reaching or pricing an Agreement.


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The District will solicit and procure an Agreement by competitive bid when feasible. Only parties
conforming to the minimum credit standards outlined in this Policy are allowed to participate in a
competitive transaction.

The District may procure an Agreement by negotiated methods if it is determines that due to the size or
complexity of a particular Agreement, competitive bidding is undesirable, impractical or impossible and a
negotiated transaction would result in the most favorable terms. The District should attempt to price the
Agreement based upon an agreed-to methodology relying on available pricing data to obtain inputs to a
mathematical model. The District will use a FA to assist in price negotiations and the determination of the
method of procurement.

Regardless of the method of procurement, the District shall obtain a finding from the FA that the terms
and conditions of the Agreement reflect a fair market value of such Agreement as of the date of its
execution.

All services related to swap transactions will be procured in a manner consistent with the District’s
standing practices for procuring investment banking and other similar services, so as to provide the
District with the highest level of service at the best available terms and pricing.

The [Director of Finance/Chief Financial Officer] may execute interest rate swap agreements and other
documents related to such transactions and may execute the documents related to similar transactions, if
such documents result in a transaction consistent with this Policy. This authorization will extend to future
termination or modifications of the initial documents provided such terminations or modifications do not
result in a structure that exceeds the Risk Limits set forth in this Policy and is otherwise consistent with
this Policy (see Active Management, below). The District must obtain specific approval from its governing
body or authority to undertake a transaction that does not meet the requirements of this Policy or is an
unusually complex transaction.

Swap Counterparties Policy

The District shall execute credit-sensitive derivative transactions only with counterparties with strong
credit ratings. While the District may have a flexible credit standard, it will attempt to do business with
counterparties rated in the “AA” category or above as of the transaction date.

For lower-rated (below “AA” category) counterparties, the District shall seek credit enhancement in the
form of:

    •   Collateral;
    •   Guarantees; or
    •   Termination events (e.g. below investment grade).

If (i) the rating of the counterparty is below the “AA” category or the counterparty’s rating is downgraded
below the “AA” category while the swap agreement is in effect, or if (ii) the counterparty’s payment
obligations are not guaranteed by another entity or if the entity that guarantees the counterparty’s
payment obligations, if so secured, is rated below the “AA” category, then:

    •   The obligations of the Counterparty will be 102% collateralized by cash or Treasuries or
        Agencies; and
    •   The cash or obligations will be deposited with the District or with an agent of the District; and
    •   The collateral obligations will be valued daily.

The District will structure swap agreements to limit losses due to non-performance of its swap
counterparties.



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The District will establish and review counterparty exposure limits. (Not to exceed amounts for a given
counterparty)

Swap Documentation

The District will use standard ISDA swap documentation, including the Schedule to the Master
Agreement as well as a Credit Support Annex (if insurance is not available or cost-effective). The District
swap documentation should include the following terms:

    •   Key provisions, including those related to early termination (such as rating downgrade) and
        collateral requirements should be the same for both counterparties.
    •   The specified indebtedness related to credit events in the Master Agreement should be narrowly
        drafted.
    •   Eligible collateral should be limited to Treasuries, Agencies, and cash.
    •   Collateral amount thresholds should be set on a sliding scale based on credit ratings of the
        counterparty or guarantors.
    •   Termination value should be determined by "market quotation" methodology.
    •   For counterparties below the “AA” category, use a credit support annex to document swap
        termination value collateralization procedures.

Active Management

The District will seek to maximize the benefits it accrues and minimize the risks it bears by actively
managing its swap program. This will entail continuous monitoring of market conditions (such as current
interest rates, credit ratings or the parties to a transaction and other relevant factors), in conjunction with
the swap counterparty and the District’s advisors, for emergent opportunities and risks. Active
management may entail modifications of existing transactions including:

    •   Early termination of an agreement;
    •   Shortening or lengthening the term of an agreement;
    •   Sale or purchase of options; and
    •   Application of basis swaps.

Each proposed modification must be consistent with this Swap Policy and the District’s risk tolerance and
should be expected to further the goals of the swap program as stated in this swap management and
debt management plan. The Director of Finance should have delegated authority sufficient to provide
flexibility to actively manage existing transactions without board approvals. Such delegated authority
should include, but is not necessarily limited to, the authority to execute modifications to documents or to
exercise actions permitted under the documents related to a transaction.

Reporting and Disclosure

The District shall provide its governing body or executive with [quarterly/monthly] reports on the status of
its swap transactions. These reports will include market values, cash flows, value at risk and other
performance measures, as well as evaluations of each transaction’s performance relative to benchmarks
or goals set forth for the transaction or the District’s general financial benchmarks or goals. The reports
will also note all material changes to swap agreements or new swap agreements entered into by the
District since the last report.

The District shall monitor and require compliance with this Swap Policy as well as then-current
accounting practices and federal, state, and local regulations and requirements




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Rating Agencies

The District will seek Rating agency review to determine materiality of any swap transaction on the credit
quality of the District as of part of it’s overall rating agency strategy.

Swap Management Plan

The District will prepare and maintain a swap management plan as part of it overall debt management
plan. Managing derivatives requires an ongoing commitment from the District’s senior management. All
senior management – not just the Director of Finance – shall become familiar with the risks and rewards
of the derivatives being considered. Therefore, to help ensure understanding and knowledge of a swap
transaction, the District’s Debt Management Plan will contain a discussion of the details of the swap, it’s
risks, rewards, and exit strategies. The following will be addressed in the Plan:

    •   Why the swap makes sense for the District.
    •   The swap counterparty’s rating and it’s implications for the District.
    •   Has the District’s governing body reviewed and understood cash flow projections detailing costs
        and benefis of the swap?
    •   Discussion of senior management’s awareness of basis risk, rollover risk, termination risk, and
        counterparty risk.
    •   The methods for handling basis risk, rollover risk, termination risk, and counterparty risk.
    •   Events that may trigger an early termination under the the swap documents.
    •   Assessment of the possibility of involuntary termination due to an Event of Default or Event of
        Termination.
    •   On a best efforts basis, determine how much an involuntary or voluntary termination would cost
        and how it would be paid.
    •   In the event of early termination, discuss how variable rate exposure will be rehedged.
    •   Identity of key personnel and/or positions involved in monitoring the terms of the swap and
        counterparty creditworthiness.




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