Global Interbank Derivatives Market Overview by victor7

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									Derivatives and Structured Products
Autumn Derivatives Seminar
Session 1: Basic Structures and Markets




Ken S hoji
September 17th, 1996
Agenda     .,




     Forward contracts

     Options
      - Calls
      - .Puts
      - Combinations

     Swaps
      - Interest rate swaps
      - Currency swaps
      - Total returnswaps

     Structured notes
     Derivative markets
Derivatives

      Derivatives are contiactual agreements
       - Forwards and futures are obligations
                     '



       - Options are contingent obligations

      Derivatives can take many "forms"

      Derivative contracts do not generally confer on the holder rights and
      values associated with direct, physical ownership of the asset, such as
      dividends, coupons or voting rights .
Forward contracts
   -- Anagreement to-buy or .sell.stock at .a
    specific strike price on a specific future
    date

    Fonvards aliow clients to take long or
    short positions
    Fonvards allow clients to lock in a price
    today
                            '. .
    Forwards can be cash settled (gains or
    losses paid in cash)

    Ali futures contracts are a form of
    forward   .'




   p-~--F~             Stock
Call option
    A Call option gives the owner the
    right, but not theobligation, to buy
    stock at n specific price on or berorc   .
    the expiry date                              .   .

    'Call buyer pays an upfront prc~nium




                   ------_-d



                    Premium $3
Option terms and conditions


   Option Seller:                        Trust Cotnpany of New York, London
                          Morgan Guari~nty
   Option:                Call
   Underlying Asset:      Common siock of Microsort ("MSIT")
   Number of Shares:      100,000 shares
   Trade Date:            September 17, 1996
   Payment Date:          September 19. 1996 (Trade + 2 days)
   Expiry Date:           Septembcr 17, 1997 ( l year)
   Settlement Date:       Se$tember 20, 1997 (Expiry + 3 days)
  Settlemeit:             "Cash" (could be "Physical")
                -     .


  . Option   Style:       "European" or "American"
  Strike Price:
  - .                     $125.25 ("~t-the-money,   in-the-money, o r out-o f-the-moheyw relative to the
                          "Spot" price on the Trade Date)

                          $15.97 ( 1 2.75% of the spot price)
.'   Put Option                                        Buy Put at $10 strike &ice, $3 premium:
                                                       At Expiration

         A Put option givesthe owner the right,        Price   Result
         but not the obligation, to sell stock i t a
         specific price on or before the expiry        $10     Put expires wonhlcss     Slack $LO - Option $3
         date                                                  No option pnyment .      Net = $7   .

         Put buyer pays an upfront plrl11i~1111        5 15    I'ut cxpircs worthless   stock'$IS- Option $3
                                                               'NO option payment       Net = $12
         Puts provide dbwnsidc price protection
                                                       $5      Put exercised            Stock $5 - Option $3
                                                               JPMmllkespayment         +Payment$5
                                                               of $5                    Net = $7




                          Premium $3
Payoff profiles




                                   Price




 P&L      Short Put   Short Call




             Price
Option spreads
                                             Buy OTC Call spread at $10 strike, $17 cap, net $2

    Different options can be combined to
    produce a specific risk profile                                                   Portfolio P&L

    In the exchange listed markets each      ~ $ 1 0 Call expires worthless           - Option $2
    option is a discrete, separatc                   No option payment
   ,transaction
                                             $15     JPM makes payment                Payment $5 - Option $2
    In the over-the-counter market options
    can be combined into n single contract




                                                      .........................
                                                                                          Call   ,
                  Prcmium $3



                                                                                  ;      .. i
                                                                                      $12 .
                                                                              -.
                                                                                                $17
                                                                 $5           $10         $15         Price
Collar
                                                Collar with $7-$15 range, no premium ('cashlk"):
   A client buys a Put and sells n Cnll with
   the same expiry date

   At maturity:                                 $ 7 - 1 5 Nocollarpayments     Stwk$7-15

    -   I f share price is lower than the Put   >$15    Client makes payment   Stock >$I5
        strike, JPM pays the difference
       between Put strike and markct
       price
    -    If share price is higher than thc              JPM makes payment      Stock <$7
         Cnll strike, client pays thc
         difference between market price
         and Call strike
   I f premiums net out the transaction is
   described as a "cashless" collar



                      Pay mcnt
    Swaps: Interest rate swaps
              . .

                                                                       ',


       A contract where counterparties
                                                           2 year swap on $100 against 6 month Libor:
       periodically exchange fixed for ilonting    -
       rate interest flows                                 Cash flows (client's nersnectivcl:

       Cash flows are generally netted against
                                                           Rak              ~~~                 mslea
       each other. There is no exchange of                 Libor            6%   8%    10%      6%
       principal either initially o; at maturity
                                                           Floating              -$3   -$4      -15   -$3
.      Swaps involve credit exposure to                    Fixed                 W     $4       $4    $4
       counterparty
                                                           Net                   $i    $0       -$I   $I
       The standard floating rate benchmark is
      ,Libor, but other indexes (Fed Funds, CP,                                                             L
       PSA) are also available                         1




                           6m Libor

           Client        Fixed 8%s.a.
Swaps: Currency swaps
  A contract where counterparties             2 year swap on $100.6 month Libor against DM150 8 %
  paiodicall y. exchange cash flows in        s.a. fixed: ',




                                                                                                    I
  different currencies                        ~ash.ffowkenS ?eW'ect iv&
                                                      s   s       I



  Flows for the 2 "legs" of rhe swap may be
  fixed or floating rate                      m           <       2EL    3m9mmslea




                                                                                                    I
                                              US$ Libor           6%     8%    10%   6%
  Cash flows are not netted against
  eachother. There --exchange of principal    US$ Floating    A   $100   -$3   -$4   -$S   -6103-

                                              DM Fixed                  DM6 DM6 DM6 DM156
                                                                  .-DM150




                                -
                    M Fixed 89Ls.a.
.   Swaps: Total return.swaps
'     Swaps can involve exchanges-of virtually
      any type of cash flow'sor asset returns              2 year S&P500 TRI swap on $100 against 6 month Libor:

       In "total rate of return" swaps the total
                                                           -
                                                           Date        9/96         9/97           3/98   9/98   +       9/98
       return of an asset is exchanged for an
      .interest flow

      While interest flows are paid on an accrual
      basis, index returns    generally paid out           Equity             $0    $0     .       $0     $20            -$I0
      at maturity            ,   -

                                                       ,   Interest           -$3   -$4        .   -$5    -%3        .   43
      Total returns can be negative as well as
      positive                                             Net                -$3   -$4            -$S    $17            -$I 3

      Swaps on fixed income, international         .
      equiiy or commodity ii~dexcs also
                                  arc
      available


                           S&P500 TRI

                                 Li bor
Structured Notes

                                                  1

    1. Investor wants to buy a note linked
    to the total return of the S&P500 TRI                                    3. Issucr enters into a S&P500 TRI
    index. JPM finds an issuer or asks                                       swap as the hedge for the note.
    MGT Nassau.                                                              At maturity receives gain or pays
                                                                        .    loss. This is combined with deposit
                                                                             rcdcmplion and paid to investor.


                                the S&P500 TRI
                                                                   S&P500 TRI

                Invcstor                              Issuer                Libor
              u
                                              $100             Li bor

         2. Issuer deposits proceeds into
         a Libor deposit. Interest flows
         offset liability in the swap.

     I   Alternatively it uses the cash
         for investments or other purposes.   I
'         0


                                                                                                     .   .
                                                                                                                            . . .
    It.




                                                                               3. EDG sells thc call option to MGT.
                                                                               Sincc a call on $100 worth of thc
                                                                               basket costs 1 1.4%. or $ 1 1.4, the $7.53


              <
                                                                               available buys 66% participati,on in the
                                                                               appreciation of the basket ($7.53 151 1.4
                The Derivatives Group launches an>       . .                   = 66%). At maturity EDG pays any
              MPD on the "European Corporate .                                 appreciation to MGT Nassau. This is
              Restructuring Basket". The 100%                                  combined with the $100 guarantecd
              principal protection version oifcrs 66Yo                         redemption amount.
              parficipntion in the basket ups,idc.
                                                                           ,
                                                                                Y
                                                                       ,



                                                                C~II option on
                                       European Rcstrucluring   Europcan stock
                                                 MPD                bas kel




                  to the bank's funding dcsk. I n 18
                  months intercst at ~ibor-25 bps.
                  produces the $100 guaranteed
                  ;edernption which we have promised
                  the investor. Nassau buys the option
                  from EDG with tlw remaining $7.53.
Exchange versus over-the-counter markets
                           Exchange                               Over-the-counter

  Products         *        ,   Listed contracts with                  +   Structures limited on1y by
                                standardized specifications                liquidity of underlying asset
  Terms                         Strike pricesand maturities set            Customized for each
                                by the Exchange                            transaction

  Settlement                    Physical                                   Physical or cash

  Exercise    .'
                                American (Random                           American or European, with
                                assignmen t of exerc,ise)                  negotiated exercise

  Credit risk                   Options Clearing Corporation -             Dealer
  Liquidity        ,   ,
                                Openoutcryauctionmarket           *.       Dealer
Derivative asset classes                        .


                                            1                                                        Commodity-
                            Swaps &                 .    Foreign
          Derivatives        Fixed          I           Exchange                Market
                                                                                ,                ,   Derivatives
                            Income                      ~erivaives             Derivatives
                         Dcrivativcs
                        .Currency .
                        .Interest rate
                                                                          .Interestbonds
                                                                           Brady
                                                                                                 Energy
                                                                                                 Precious meta
      .
      St~ks
      Baskets
      .
      Equity indexes
                        .
                        .Treasury
                        . Indexes
                                            I                             .
                                                                          ,         rates
                                                                           Currencies
                                                                                                 Base metals
                                                                                                 Agricultural
  -                                 .   .   I                         b




          Derivatives     Derivatives                   Dcrivatives           - Der iva t ivcs
                      Plcasc kccp i n mind...

                      -This hooklct is intcndcd lo inrorn~  you olprcducrs and scrviccs ,dr~rid      hy       T h i s n~alcri;tl-is in~cnrfcd nn ortcr or solicitation Tor thc purchasc
                                                                                                                                   no1          as
,        ,
                       J -1'. Morgan. J.P. Mjrgan is thc mi~rkcting n:anc Ibr J.1'. Morgan & Cu.              or s;llc o ;my li~~nncial
                                                                                                                        r                instru~~~cnt. Specific rcrcrcnccs arc for
                 '
                       Inuorporatcd and its subsidiwics worldwidc. Rclcrcnccs 1i1"J.P. Morgatt"               illuslmlivc purpscs only. J.P. Morgan may hold a position or XI a      s
                       cnc'ornpass its w~rldwidc  nclwork of subsidinrics, ir~uluding   Morgan                r~larkct  111akcr a rhc linanciill instrumcn~s markcts rclcvanl r MPDs.
                                                                                                                                i                            or                    o
                       Guaran~y   Trusl Cotnpany of New York. J.P. Morgan Sccuritics Inc.               - ,   J.1'. Murgan nay cngagc i n l~cdging otllcr opcrations'in such mnrkcls
                                                                                                                                                        or
                       (JPMSI), J.P. Morgan Invcstt~lcnt i m a g ~ ! c ~Inc. J.1'. Morgan
                                  and                          M              lt                              rclcvan! t o its MI'D cxposurcs.
                       Sccurilics Inc. JPMSI is a mcmhcr of thc Ncw York Slack ~~XC~I:III~L'. f!ic.,
                       thc Naiiuniil A<srxi;~tioai,fSccurilics Dcatcrs, Inu.. ;~ntltllc Seutirilics           JI'MSf's ~,hligillionsr l l l t l thc sccuri~ics
                                                                                                                                                             sold, offcrcd, or rcconuncndcd
                 .   . Invcstor Protcc~ion  Carporation in thc Unitcd Sl;!tcs ;utd rlrc Socuri~ics  ;u~d      h i JI'MSI ;ire rr,t dcpc;sils and ;Ire nol' ii\s"rccl by !hc Fcdcrul Dcposil
    ..                 Futurcs Associalion in tllc Uni~cd  Kingdoal.                                          l~~surnncc                ihc
                                                                                                                          Corpc~ri~liu~l. 1:cdcrril Rcscrvc Donrd. or any olhcr
                                                                                                              govcrnn~ct~lal   ngcncy. JPMSI is 1101 ; bank and is a scparalc Icgal,cnlily
                                                                                                                                                     I

                      Opinions and csiimalcs oifcred constituk our judg~ncntand iirc suhjccr to               from its hank and thrirt aTliliatcs. Thc ohligations OT JPMSl arc no1    '  ,   ,
                      changc wirhout nolicc, us ari starcknts un linanciiil ~n;irkcttrends, which         '   obligil~ions its bank or thrift arliliarcs (unlcss cxplicilly stalcd
                                                                                                                            of
                      arc baqcd on currcnt markcl condi~ions.    Wc bclicvc rhc information                   olhcrwisc), and thcsc aCliliatcs arc no1 rcsponsiblc fo; xc'urilics sold.
             .        providcd hcrc is rcliablc, hul i f should not hc nssurncd to bc ciiliur                 ol'l'crcd,or rccoi~~~ncndcd by JPMSI.
                 .    accurate or complclc. Past pcrrormancc i s not inclicntivt: of' futurc rcsulls.
                                                                                                              Addi~ir,n;lliafo;rrla~ion is nvailnhlc on rcqucsl. Q J.P. Morgan & Co.
                      Thc vicws and straicgics dcscrihcd lnay not bc suirilhlc for a l l iuvcslors.           It~corpr;r!cd1996. - ,
                     This prcscntatiqn i s not intcndcd lo provide, and should not hc rclicd ti11
                     for, accounting, Icgal. or tax advicc, or invcs~nrcnt                     Yr~u
                                                                            rcconilnc~~di~tions.
                     should consult your tax-or lcgaf advisor'atwut l l ~ c
                                                                          issucs discussed hcrc.   .
                                                                                                                                                              .   .
Derivatives and Structured Products
Autumn Derivatives Seminar
Session 2: Essential Investment Strategies




Ken Shoji
September 24th 1996
Why use derivatives?

      Leverage
      Generating income    '




       - Swaps
       - Selling Puts
       - Selling Covered Calls
       - Percs

      Options in asset allocation
      Total return swaps

      Foreign exchange forwards
Leverage in options

     ,   Options can often provide.higherleverage than can be obtained through
         traditional forms of borrowing

         "Risk free interest rate" i s Fnctorcd into option pricing



                   . .                       Retl~rn comparisons: Thy stock at $100 against buy ATM
                                             Cali for $5 premium:   -
                                             Price   2u&r!JxBalL              Cdl     m m
                                             $125    ,2596       25%          $25     $20    400%

                                             $120     20%        20%          $20     $15    300%




              Op~ian     -   .   Stock
                                         I
Leverage in swaps         .




      Swaps involve no cash upfront  -
      they'can provide 100% leverage
      They do result in credit exposure
      which must be managed
     Total return swaps allow investors
                                          -
                                              Total
                                           Return
                                          on Asset
                                                      1
                                                      A
                                                              Client


                                                                       Lihor +I00 bps
                                                                          . .


     touse our balance sheet and
     financing capabiliiies   ,
                                                          '   JPM             -
                                                                        L i h r 25 bps
                                                                                         Lender
                                                                                  -
     Swaps may have tax, accounting
     and regulatory advantages over.
     buying the asset directly
                               - .            Asset                    $100




                                                      u   Market
Monetizing positions using swaps

                    Swaps can be used to monetize the     I . seil stock:
                    value of assets (generate cash)                                Stock -
                    without sacrificing economi,~           Client
                    exposure

                    Since swaps require no cash
          . -       investment returns are fully
                                                          2. Enter inlo swap:'     -
                    leveraged
                                                                            Srock total return.
                    ~owev&,sinceswapsresultin        ,                                            .   .


     ..             credit exposure, we would generally
                    require collateral
 .   a       Swaps may generate higher loan to
           . asset ratios compared to,
                .
                                                          3. Reprircltme stock nt matrrrily:
             collateralized lending                                               Stock -

                                                           Client
Monetizing positions using swaps

     ,   Swaps can be used to convert capital   I . Enter irtln swap:
         returns into current income returns
                                                pp+pF)
                                                               Stock total return

         A client with a stock paying no
         dividends who needs income can
         convert equity returns into money
         market or fixed income returns
                                                2. Sell $rock nf matrrrity:


                                                      '
                                                ~Client I J P M I
Selling put options
                                                  Sell Put at $10 strike price, $3 premium:

 *   .   Why sell " ~ a k e d
                            Puts"?
          -   Generate premium incomc             $1 0    Put expires worthless    Option $3
          -   Conviction that price will                  No option payment
              not decline                     :   >$I0    Put expires wonhless     option $3'
                                                          No option payment
          -   "Happy ,to buy at that price"
              if exercised                        ~ $ 1 0 Put exercised
                                                          Client makes payment     - Payment ($10-Stock

                      Stock



                                                                      $7


                    Premium $3

                                                                               .   .
                                                                                        I   .




                                                                                        $15     Price
Selling call options

    Why sell "Covered Calls"?
     - Generate premium income
     - Conviction that price will
       not rise above strike price
     -'"Happy to sell at that price"
       if exercised -




   p - ]
  p- J J
          ..
                 Stock




               ------    @   *'
                                  I
                                  -


               Premium $2
     Another M l s s s d Opportunity
     Sometimes I t just doesnWc      pay to hedge. O n
     Frlday afterrroan. an l n s t l t u t l o n a l investor,
     evldentiy concern d that an investment In
     MFS communtcafions was nor moving,
     declded to plck up a H t t l e income by setllng call
     optlons on the stock. T h e rtek was the investor '
     would mtss out on any rlss In tho stock. ?hat
     was exactly what happen& when M F S eald it
     had agreed t be acqulred by Worldcorn.
                 o
     Floyd Norrls :Market Place. [ P .
                                    61

                                     -



I
                                                                                              '
        THE NEW YrlRlC TIMES, TUESDAY. , A UGUST                             27, 1996



    Market Place 1 Floyd Norris                                                       .
                                                                mukcr In MFS optinns nf ~ h n              Chlcop,o nnrhrrl      1)uycrs hnd lnstdc Information.
    'A merger dcal shows once                                   Opllons E*chnnec. Hcrilornln Nltktl. nn olliclnl of                                  for
                                                                                                                                    A sp3kc~wdm~n the Chlcntn owchonge Inid
       -     -     -     - -                                    Opl4ntls Hcsnurcc Group, snld the lnstltrhtlnn Ittnt             "lhc ewchanfis Is conductlnu n routine lnqulry on
                     ~
    again that i t *all in the timing.                          sold the Opfions had hccn ollerlng to scll tho cltlls            thc irndlng."     trul would ~ lcornmcnt further.
                                                                                                                                                                    l
                                                                lor a subszantint pcriod o l timc &tore hls Rroup                   Such Inwstlgations arc rndnd rrmrkrc. but they
                                                                bought Ihcm. He w w l d not Idcnllfy tllc Insrlthitio~l.         Pre Rllt oftcn that producrlvc. The crrhangcs can
           OMETIMES 1 jusr doesn't pay to hcdne,
                           1                                       Mnrkcl n~nkcrs!alund rcndy In buy nlld scll
    S          On Friday n l t e m n . nn lnstltutlonnl ln-
            vcstor, tvldcntly conternd that an Invosl-
    mcnt In M P S Cornmunlratbns was not movlne.
                                                                olltlnns. 1)ut nrity I f tllc crlvtnnlar In wllllng to do an
                                                                a1 R "hld-nskcd'' liprcird. I r l thls cnrc. lhc Instltu-
                                                                rinn wnr w r l H n ~ scll thc aptlnns only ul the
                                                                                       to
                                                                                                                                 gcr brokeroga llrma tosay who the customer was.
                                                                                                                                 but lhay cnnnot tnrco the customer to tcsttly.Thc
                                                                                                                                 Sccurlllaa and' Exchange Cornmlsslon can lasuc
                                                                                                                                 subpocnal. but If a cuslomcr ehooxs to rcrnaln
    bcelded to pick up o little Income by *clllny: Cull         h i ~ h e r d d ~ ~ I C C . L l hnrl l a wnlt for wnlcnnc
                                                                          a                80                                    allont, or dcnlcs dolnc nnylhing wrong. Illrlc cnn
    options an the slack.                                       m nGrcc In ~ h truda.
                                                                                   c                                             h dune u n t m the tnvcrll~alom        cnn prove how
        Ihe call options would give the buyer the right                                       I         I                        Inst& Informntlon came to Iha cuslomer. m a t i s
    r putchnst hlFS stock at s~clfilrd'prlccunlll
      o                                                             I'or the InsltluHnn. tlle trade b r w g h l In $43.750,      oltm vcry dllllcutt to accomplish.
    Sept. 20. when the options would ewplrc. The                less co~nnllsstons,but thc Institullon mlsrcd out                    In lnlcrvicws ycstcrdny, execurlvcs from the
    income tmm selling the colls wmld provldc the               on the gain from ycsterdny's bll: run-up In MPS                  two cornpanlcs sold they hnd done rveryrhtnk
    lnslliutlm wlih a partlol hedge against any dc-             shnrer. Ar for ~l~c.Olbtions          Rcsor~rccCroup. Ihc        p s l b l e to keep thc deal comtldentlal. and cx-
    cllnc tn the Pw)r prlce. The rlak was that Ihc              trrldc could hnvc pruvlilcd n windlnll slrtcc tltc               prusrcd surprlac ar qucsltona regarding ~ r i l l l c
    ~nstltutlon   would miss out on lhe galns II t h e sfmk     op~lotm.wl\lclt i t tmu~lttInr $1.75 cach. closed                lnsldcr l r d t n p . ncmnrd J. Bbbers, thc president
    was to r l K sharply bctorc the cxplrallon datc.            ycstcrdny at SIO, lor a total vnluc ot f250.000.111er
        hnd trtdred them w m a rise. Yesterday it wns
                                                                                                                                 nnd chlct crccurlvc ol Worldmm, snld. "I don'l
                                                                rrndlng as hlgh as 511.A75. llur Options Rcmurcc,                know nnyfhlnp obnul it. and I don't know how yau
    announced thnr MFS had agreud to be nequlrd
    by Worldmm Inc.. with each sharo of MI:S to bo
    c ~ c h m g e d tor 2.1 shnrts of Worldcorn. MI:S
                                                                       h hcd&cd,ltsposlllon. Mr. Nilkit ~ a l d1 1
                                                                tw, r ~ d
                                                                E R I C by sclllnf. so~llv   MPS &lock slttbrt
                                                                bnrrnwlng shurcs nlrd svllttrg 1t1cln. ThO chOrt
                                                                                                                 -     .1 thls
                                                                                                                       111 s
                                                                                                                      111 I
                                                                                                                                 cnuld knirw about It." HE nddcd, "I nm absolutely
                                                                                                                                             z truw we nrc alrlu to do this dcnt withaul
                                                                                                                                 n ~ n r ~Ilyd
    shares shot up, and with them tha vnlue of Ihc              p s l l i n n Inst mnney whcri tltc stock raw, bccauso           ally word galtln(l wt."
    options. MFS ended the dny at $41.81. up $9.94.             the eharcs sold short must be rcpurcherd nt                         H c nnd James Q. Crowe. the charrman 01 MFS,
        Acrlvlty tn options just before thc nnnounce            hlghcr prlccs. So rhc losrcs on the short pUHlllnn               sold lhcy hammered out ~ h c       dcrl ln two weeks.
    mcnt 01 a deal ottcn shows slgns of hslrtcr                 Inrgely olfsct the proilt on thc oprlons trade.                  Worldcorn's board mcl.on Pr~dayo discuss tho
                                                                                                                                                                          l
    trad~np.   and thcrt may hnvc been somc of [hat In              Mr. Nltkn saltl I l l s llrm lnst l ~ t n t ~ ovur nll or1
                                                                                                                  cy             dcal. and npprovcd I t on Sundny. The MI'S &aid
    thc trading a MFS oprjans on Frlday. Uut thc
                     l
    bjgptst b l c ~ of that day
                      k          - 250 ~ p i l o n s
                                                   contracts.
                                                                ttlc tabcovcr. Iar(:cly hccnusc of snlm ot c:~!t
                                                                uptlons tbllowill(l rlw huycr to purchasa MPS stock
                                                                at 540 n share. 'lltosc optlnns wcrc purchasd by a
                                                                                                                                 mct four llrncs on the dcal In the lust rum weeks.
                                                                                                                                                          on
                                                                                                                                 h l o r c upprovlnp IL Saturday.
                                                                                                                                    "Wc t m k cxtruartlinary mcssurcs ro kccp rhls
    cach of which allows lhc lwycr 10 purrhaw 100
    J h n m of MFS at U S t l ~ m g h
    to bo a c w c of wmethtn~
                                      Sept. 20
                                  clro.
                                                -    apptnrs                   of
                                                                n~rnillcr brokcrnl:c I w u K S on I'rldliy. wltctl
                                                                MFS wrrs trndln~; nruuntl 533. Conlrncls llbat SoHltrl
                                                                                                                                 nnnuunccment confidcntlal," Mr. Ctolwe soid.
                                                                                                                                                     ~
                                                                                                                                    Whclhcr t h optsons scttvlty rcf~ccts rahlurc
                                                                                                                                                                             thc
        7he buyer of the opttont win* rho O p t m s R e         Inr 50 cc~lts     nnd lcng ott Frldny cndcd ycstcrday ot         of lhosc mc;rsurcs, or just somc ~d may      luck.
     rource Crmtn. the dcslgnatM primary mnrkst                 $5.15. I t Is cnncclvahl~      fttnt sntna at (Irosv nptli,nt    novar t IImwn.
                                                                                                                                           m
Percs
                                                  .   ,


        "PreferredEquity Redemption Shares"
        Debt securities exchangeable into common stock (not necessarily stock of
        issuer)

        In exchange for additional coupon investor forgoes equity appreciation
        above cap level ,
         -   ~nvestor~artic$at'esfull~innppreciationuptocap
         -   Investor has full downside exposure on the stock

        Investors are effectively buying stock and selling "out-of-the-money"   '       .

        calls

        Derivatives permit investors to express preferences between capital and     )


        di.vidend/income returns
Percs example

    ,   .   Price:                  $20 (same as the underlying stock price at time of issue)

            Conversion Price:       $25 (25% premium)
                                      >   -
    ,
            Maturity:               3 years

            Coupon:-            l   6% of issue price p.a.
            Conversion:             If stock price < conversion price, one share per perc
                                    If stock price > conversion price; shares calculated by
                                    dividing conversion price by stock price .
                                                                 -

            Seniority:              Preferred stock of.i ssuer
                       r-

            Listing:                NYSE or exchange wherecommon is listed
            Stock dividend:         2109% pea.,                      . ..
Percs valuation

      The strike level of the "out-of-the money" Call and the incremental
      dividend are variables which can be adjusted




                                 -
                                 CaII value spread over life of Perc at
                                 issuer's discount rate of 8% =
                                 4.00% per annum
       10.31% Call Value




                   Yr 1 ' .      Yr 2       Ur 3    Common dividend
                    -   ,   ..
Total return swaps

      College endowment fund has invested $40 million in a long term fixed
      income portfolio for many years

      Active fund manager has consistently underperformed their benchmark,
      the Lehman Brothers Government and Corporate (Long) Bond Index-

      College looking to improve cost/performance balance
Solution: Index swap with bond portfolio

   College invests cash in portfolio of     .

   bonds
                                                                Portfolio
    .-   High quaZity(AMAA) tominimize                 ~orh  Flmr Plan Lihor + 13
         credit risk                                   A 7 T Crcdi~Cards 1,ibr + 12.5
                                                       First USA Credit Cnrd Lihor + 24
     -   Libor basedflows oflset swap liability        Nationshqnk Ploalcr Lihr + 15
                                                       First Chicago Plonter Lihor + 13
         Portfolio i held in JPM Asset Account
                                                            ,( )
     -               s
         and pledged as collateral ngninst
         exposure                                                              , L i b o r + ! - 1 5 bps   ,




   College and Morgan enter into total
   return index swap                                            Client
    - Morgan pays cumulative appreciation of
      index a1 the end of 5 years                 Lehmiin                        Li bor +5 bps
                                                  . Index
    - College pays any index deprecintion,
      plus periodic interest cost
                                                                 JPM
   Strategy should result in outperformance
                                                            -
   relative to the index
Why use total return swaps?

         passive investment philosophy
          - Client may want broad market exposure
          - M a y not believe in "alpha"

         Lower transaction costs
          -   Client &n share in cost snv jngs i f h a l e r usex futures

         Operational convenience or speed of execution
         Create synthetic short positions
     .    - Go short markets where "plzysicnl" transactions are expensive or d i ' c u l t

 .       Financing transaction
          -   Use dealer's balance skeet and funding access        '




         Tactical asset allocation
          -   Switch out of existing portfolio into ofhe; asset classes
Exploiting interest differential'sin international markets
                Mechanics and outcomes       .   .   -   ,




       Today


                                                              Lender



,-     u
     ,-,
           11   Borrow
                Yen tOO million @ 270

                            Yen     b
                                                                    Yen 102 million
                                                                                      @ 3213.00
                                                                                      sell $850,000
                                                                                      $220,000 profit

                                                                                      @~oo.o~
                                                                                      sell $1.02 million
                                                                                      $50,000 profit


           1                                                                          @95.32
                Buy 7% bonds            /OO.OO
                                                             (1   - $1.07 million
                                                                                      sell $1.07 million
                                                                                      break-even



                                                             0    Bonds               e85.00 . -
                                                                                      sell $1.2 million
                                                                                      $130.000 loss
                                                                                                           ,
Forward contracts
              *.


,   Since Forward Exchange Rates are calculated using interest rate differentials
    between the two currencies, the outcornes.should be the same as thk "physical"
    transaction

    The forward market is liquid and generally involves lower transaction costs

                                                                                            Possible oritcomes
                                                                                            al varying   Yen/$ rates:


                                 Sel I                              I yenr ' time
                                                                           s                scl I$850,000       .
                                 Yen102 million                                             $220.000 profit

                                                                                            -el00.00
                                                                                            sell $ f .02million
                                                                                            $50.000 profit
                                 BUY                                Spnr FX Rate:   ,   .
                                 $1.07 million                             1
                                                                                            sell $1.07 million      .
                                                                                            break-even

                                                                                            @85.00
                                                                                            se11.$1,2 million
                                                                                            $130,000 loss
Please kccp in mind ...

This hooklet is intended lo inform you of products i~ndscrviccs cdTurcrl hy      This miiwri;~li s not intcndcd ;ts an nrrcr or solicitii~ion ~ h purchase
                                                                                                                                              Cur     c
J.P. Morgan. I.P. Morgan i s the markcling namc Tor J.P.Morgan nt Ca.            or s;dc nl'itny linancial instrument. S ~ c i f i c
                                                                                                                                   rclcrcnccs arc lor
Incoqmrated and its subsidiaries worldwide. Rcfercnccs to "J.P. Morgiln"         illustrative ptlrpscs only. J.P. Morg;in rnay hold n position or acl as
encompass its worldwide network or suhsidiarics. including Morgiln               mnrkct tnakcr in the linnnviat in.~lrumcnls m;akcls rclcvant to MPDs.
                                                                                                                               or
Guaranty Trust Company of New Yark, J.P. Morgan Sccuritics Inc.                  J.P. Morgnn may cng;lgc in hcdging ar olhcr optalions in such markcts
{JPMSI),and J.P. Morgan ~nvestment     Manogcmcni Inc. J.P. Mnrgnn               rclcvrint to i l s MPD cxpnsurcs.
Securities Inc. JPMSI i s a member of the New York Slouk Exchange, lnc.,
the Narionat ~ssocin'tion oisecuritics Dealers, Inc., ant1 the Sccuritics        JPMSl's ohlig;~~ions lhc sccuritics sold, oflircd, or rccom~nended'
                                                                                                         and
Investor Protection Corporation in the Unilcd St:llcs n~lrl Sccuritics :mtl
                                                           tllc                  hy JPMSI iIrc not dcpnsifs ant! :ire not insurcd hy the Fcdcral D e p s i ~
Futures Association in the Unitcd Kingdom.                                       Insurilncc Corporalinn, Ihc Fcdcml Rcscrvc b a r d , or any nlhcr
                                                                                 ~ovcrnnicr~t:~l  ;igcncy. JPMSI is not i t hink :~ndis :I scparalc legal cntity
Opinions and estima~es   orrered constilule our judgnlcnt and arc suhject to     liom its bi~nk thrin atfilialcs. Thc ohlig;trions o JPMSI arc not
                                                                                                 ilnd                                    C
change without not ice, as are statements on linanciihl tnarkcl trcnds. which    ohliglions or its hank or lhrirt nffilia~cs  (unlcss explicitly sralcd
art baed on current market conditions. W heticvc rhe informi~tion
                                            e                                    nrhcrwisc), and lllcsc irrfilii~~cs not respnsihle for securities sold,
                                                                                                                   arc
provided hcrc is reliahlc, hut i t should no1 he assumed In hc eichcr            ol'rcrcd, or rccclmmcndcdhy JPMSI.
accuraie or complete. Past performance is no1 indicalivc of tt~lurc   rcsalts.
                                                                                 Additinnal infonniilian is avnilahlc on rcqucxl. 0 J.P. Morgan & Ca.
The views and srraregies dcscrikd may no1 he suilaMc for all invcslors.          Jncflrporillcd 1906.
This presentation i s not intended to provide, and should not he rcticd on
for. accoun~ing,legal, or lax advice, or investment rccornmcnda~ions.    You
should consult your tax or legal advisor q h u t the issues discussed hcrc.
    .Derivatives and Structured Products
    Autumn Derivatives Seminar

'   Session 3: Hedging and Diversification Stmtegies
Agenda


      Overall considerations

      Market, regulatory and tax considerations          -,




  .   Hedging and diversification strategies
       - Stock sales
           -.




       - Equity puts
       - Cashless collars                       ,    .




       - Short againstthe boxwithamarginloan

       -        Equity linked loans
       -        Exchange Funds    -                           .. ,..   .,
       -        Charitable Remainder ~ r i i i t s
     Overall Considerations


          Current posltlon
                      m   .

                                        Conside     ons / constr
                                                                                .,   .
                                                                      Future obiectlve

     ..   Current overall asset         ~ o r of ownership
                                              h                       Desired risk / return
,-        allocation                                                  profile

          Amount of wealth in single    Potential tax liability for   Ultimate beneficiary of
          stock                         low tax basis stock           wealth

      '   -Viewson current risk        .. Current and future tax      Time horizon
          /return of assets             position

                                        Regulatory restrictions and   Income needs
                                        reporting requirements
Market and Regulatory 'Considerations


    Market considerations
     - Daily average trading volume
     - Size of holding relative to market capitalization of company
     - Investor demand for large blocks of stock
     - Depth of stock lending market
    Regulatory considerations
     - section 13(d).
     - section 16
     - Rule 144/ 145
     - CFTC restrictions
Stock Sales


       Liquidity is generated

       Tax cost can be significant

  ,
       Risk is reduced through diversification
      - Most appropriate for those with long timk horizons

       Stock sales plus tax advantaged/deferral vehicles can make sense
Equity Put


                                                                                         Single stock
    Provides protection against a decline in the                                           returns
    value of a single stock                                          Client
    Client pays an upfront premium and, in return,
    MGT.agrees to pay the difference between the       -
    strike price on the put and the market value of
    stock at maturity

    Strike prices can be set at-the-money to lock in                   At maturity,
                                                                       maximum of: 1)
    100%of stock value today or can be set out-of-                     zero and 2) strike -
    the money (10%-20% below the current price                         price minus stock
    is common)                                                          price multiplied by
                                                           Upfront      the number of
                                                           premium     .options




                                                       Morgan Guaranty
                                                        Trust Company
                                                       1
Cashless Collar


       Same downside protection as put option, but                                                    Single stock
       upfront premium eliminated by giving up some                                                     returns
       potential upside in the stock                                          Client
       Consists of buying a put and selling a call with
       same maturity
        - Specify level of downside protection
                                                                                 At maturity, maximum of: 1)
            needed (e.g., 10%-20%OTM)                                            zero and 2) put strike niinus
        -    Strike on call set to generate premium to                           stock price multiplied by the
         .   pay for put -                                                       number of options
                                                                       I

                                                          At maturity, maximum of: 1)
   .   At maturity, payout of the collar depends on   zero and 2) stock price minus
       market value of stock .                        the call strike multiplied by
                                                      the number of options
        - If share price < put strike, MGT pays
            difference between put strike and +market
           price
        - If share price > call strike, you pay               ;   Morgan Guaranty
            difference between market price and call
            strike                                                  Trust Company
                                                                   -
Short against-the Box...


              ,Execute short with borrowed stock: equity
               risk neutralized
              Borrow up to 90% of the value with a
              margin loan (loan proceeds are available
              to reinvest in public securities)                      I
                                                               Stock "in box"
          ,   Closed at any time with 3 days' notice;       (via margin account)        Rebate income
  -
      .       typically used at year end to defer gain to
              next year                                                                           Sell borrowed
                                                                                                  stock
                                                                         J.P. Morgan
                                                                          Securities
                                                                                            ,   1   Cash
                                                                                   I
                                                                                Cash
                                                            ,   Stock Loan    Collateral Rebate income
With a margin loan


    Pay floating rate interest on margin loan                                   New returns
    outstanding
                                                              Client
    Net cost = rebate income - margin loan
    interest                                                                    Reinvestment
                                                    I
                                                Interest on
                                                margin loan       Margin loan



                                                        J.P. Morgan
                                                         Securities
                                                                                I
,.   Equity Linked Loan


         Loan is secured by underlying stock plus
         additional collateral
           - Interest payments equal annual spread.plus                         Client
               any dividends paid on stock
           -       Amount of loan repayment equal to market
                   value of stock, subject to minimum
               .   repayment amount of 50% of initial loan
                   proceeds

         Equity risk neutralized: change in value of stock
                                                              secured
                                                                loan        I
                                                                        $10MM of
                                                                                         spread o
                                                                                         $I OMM
         offset by change in loan repayment amount                      shares plus
                                                                         additional             Market value
         cash' from loan is available for reinvestment or                collateral             of shares
                                                                         pledged                at maturity
        .other purposes

         Additional collateral required depends on credit
         analysis and how the loan proceeds are invested
                                                                        a n
                                                                ~ o r ~ Guaranty
         Not a disposition of underlying shares for tax          Trust Company
         purposes
Equity Swap

   '
       Total return of underlying stock exchanged for
       total return of market index such as S&P500
       Index
       Underlying equity risk neutralized:
         - Any decline in value oEstock offset
           by payment received under swap
       -   Any increase in value of stock                        Annual               Stock
           offset by payment due to Morgan                        spread           depreciation
       .   under swap                                         plus dividends   -
       ,
                                                                                             Total return
                                                                                             of S&P 500
       Fixed cost equal to annual spread on initial                       Stock                 Index
       market value of underly ing 'shares    .       .   .            appreciation,              I



       Not a disposition of underlying shares for tax
       purposes
                                                              *
       Swaps against other market indices such as                  Morgan Guaranty
       fixed income or international equities are also
       available                                                    Trust Company
                                                                  -
Exchange Fund


      Clients contribute shares into an "exchange" or
      "swap" fund established by JPM as the general
      partner
      In return clients receive partnership units
      representing pro-rata stake in all contributed
      shares

      At the end of the holding period fund is   '



  .   liquidated

      Single stock risk is exchanged for diversified
      portfolio (up to 99 shares)

      Clients retain original tax basis in the shares on
      distribution                                         Exchange
                                                            Fund
                                                                      I
Charitable Remainder Trust


       Low basis stock gifted to Charitable Remainder
       Trust     -
      . -
                                                                           client
             Trustee can sell stock without incurring ;

             capital gains tax
        - Trustee reinvests proceeds in diversified
             portfolio                                    .    Gift low
                                                              basis stock
      You (and your spouse) receive an income                       I                    b
                                                                             Annual inc me stream
      payout for life; charity or family foundation
      receives remainder interest '




 '*   Allows tax free diversification while meeting
      .long term charitable intent
        - Tax deduction for present 'value of future
             gift to charity                                                  I .
                                                                        Remainder interest
        -   Wealth to heirs can be replaced and
            increased with insurance and/or CRT                              t       -
            with heirs as income beneficiaries
                                                                        Qualified
      Reportable as gift byinsiders                                     Charity
Comparison of Diversification Strategies



                                              Equity
                                  Short vs.   Linked             Equity     .   Exchange
                      '   Sales   TheEhx      - - S w a a                       Fund          CRT
Defer capital gains       Low     Moderate    Moderate           Moderate       High          High
Investment flexibility    High    High        High               Moderate       Low           High
Provides liquidity        High    High        High           '   Low            Low           Moderate*
Long term solution        High    Moderate    Moderate           Moderate       High          High
Rollover risk             Low     High        High       .       High           Low           Low
Certainty of cost         High    Low         Moderate           Moderate       High          High
Control of assets         High    High        High               High           .Low          Low,


                                                                                           * Income only
Case 1.:Structuri,ngthe appropriate vehicle



     1-
      l
     c1 QFl
     Jack Ellis Jr.    Vanessa Ellis   lare Matthew    Karen Corsair
                                                                        Stock price




      John ~ l l i s                   Jar Matthews    Vick Corsair
       -43,146                             43,145         30,343




     Richard Ellis                     lisa Matthews   Dennis Corsair
        43,146                           43,148           30,343




      Klye Ellis                                       James Corsair
 .     43,146                                             27,400



                                                                         Oct 95   ';   Oct 96
                                                       Travis Corsair
                                                          22,747




                                                       Luke Corsair
                                                          22,717
Case 2,: Monetizing illiquid preferred stock                                                     .   .




                                                                                                                  *

   At inception:                                                              At maturity:
                                      Market                                   . .                       Market


                                                  Zero-coupon     '       A

                   Cash ( 1 9%)                                                                                       Cash ( 100%)
                                                  Note (25 yrs)
              '   Stock                        v,                                        Stock                    I
                  Dividends            Thst                                   Client                     Trust
                     -                                                1
                   Cash
                   (81%)                          Notes                                                               Cash (1 00%)
                   Cash (1 00%)
                                  r


                                      Investors
                                  -
-Please keep in mind ...

This booklet is intended to inform you of products a i d sewices offered by   This material is not intended as an offer or solicitation for the purchase
J.P. Morgan. J.P. Morgan isthe marketing name for J.P. Morgan & Co.           or sale of any Xnancial instrument. Specific references are for -
Incorporated and its subsidiaries worldwide. References to "J.P. Morgan"      illustrative purposes only. J.P. Morgan may hold a position or act as
encompass its worldwide network of subsidiaries, including Morgan             market maker in >he Xnancial instruments or markets relevant to
Guaranty Trust Company of New York, J.P. Morgan Securities Inc.               MFDs. J.P. Morgan may engage in hedging or other operations in such
(JPMSI), and J.P. Morgan Investment Management lnc. J.P. Morgan               markets relevant to its MPD exposures.
Securities Inc. JPMSI is a member of the New York Stock Exchange, Inc.,
the'~ationa1Association of Securities Dealers, Inc., and the Securities       JPMSI's obligations and the securities sold, offered, or recommended
Investor Protection Corporation in the United States and the Securities and   by JPMSI are not deposits and are not insured by the Federal Deposit
Futures Association in the United Kingdom.                                    Insurance Corporation, the Federal Reserve Board, or any other     ,

                                                                              governmental agency. JPMSI is not a bank and is a separate legal entity
Opinions and estimates offered constitute our judgment and are subject to     from its bank and thrift aPAliates. The obligations of JPMSl are not
change without notice, as are statements on !Anancia1 market trends,          obligations of its bank or thrift aphliates (unless explicitly stated
which are based on current maiket conditions. We believe the -information     otherwise); and these af'hliates are not responsible for securities sold,
provided here is reliable, but it should not be assumed to be either          offered, or recommended by JPMSI.
accurate or complete. Past performance is not indicative of future results.
                                                                              Additional information is available on request. O J.P. Morgan & Co.
The v i e w s k d strategies described may not be suitab~kfor all investors. Incorporated 1996. '
This presentation is not intended to provide, and should not be relied on .
for, accpunting, legal, or tax advice, or investment recommendations. You
should consult your tax or legal advisor aboui the issues discussed here.
Welcome to SunGard Securities Processing                                                                   Page 1 of 2




                                                                                  Account rhk rruamrnt (ARM)
                                                                                  EIecfmnk statemants/rcport. (dolk)
                                                                                  Alloutions/aaims processing (FACT)
                                                                                  Internet inquiry
                                                                                  CCP initiatives
                           Futures

dutions
 Fa~tsr
   GMI
                           The GMI System is a powerful back-office clearing and accounting
   octagon
   Devon                   software solution for the global exchange-traded derivatives, equity
   Gbbal Margin Server     and equity option marketplace. Clearing firms, securities firms,
   GDS Prldng Data         brokerage houses, emerging derivative playen and the regionalized
   WorMSouKe               investment community rely on GMI every day for acquisition,
   Exchange Gateway        processing, management, dissemination, integration and booking of
   Aud ITrade              all clearing and trade processing actiiitiis for virtually any
   AudITlack               exchange-traded instrument.
   Supported Exchanges
   Professional Servlces
   Tralning/Dmmentatlon    GMI removes manual processes and provides comprehensive,
   Futures News            consistent and accurate information 24 hours a day in one integrated
   Industry Links          accounting system. It ensures that resources are better allocated, so
   Futures Contacts
   Customer Login          your firm can remain competitive and control costs. GMI also
 InWathr                   provides links t o the world's exchanges for automatic trade capture,
                           pricing updates, margins and risk arrays.
 Phase3
 stream
                           Among GMI's core capabilities:
STNs e t t k m w s
Wdl S L C t n l ~
                                   Automated Point Balance
                                   Automatic Reinstatement of P&S
                                   Auto-Maturity of Government Instruments
                                   Collateral Allocation and Management
                                   Commissions and Fees
                                   Credit Compliance
                                   Dividand Processing
                                   Document and Papars Maintenance
                                   Equity Options Processing
                                   floor Brokerage Tracking
                                   Foreign Exchange Processing
                                   Give-Out Statemants
                                   Haircut Cakulations
                                   Interest System
                                   Integrated General Ledger
                                   Multipk Broker Table
                                   Multi-Currency, Global Rocassing
                                   Multi-Firm Processing
                                   Philadelphia Currency Pmassing
                                   Random Assignment of QpUons
                                   Real-Time Pricing
                                   Regulatory and Year-End Tax Reporting
                                   Single Currency Margins
                                   T-Bond Processing
                                   Warrant Processing

                           GMI supports the following instruments:

                                   Future and futures options
                                   Foreign exchange
                                   Over-the-counter options
                                   Stocks, rights and warrants
                                   Equity, non-equity and currency options
                                   Corporate, municipal and sovereign govarnmnt bonds
Welcome to SunGard Securities Processing                                                             Page 1 of 2




                            Futures

rcplutlans                  Devon
 F*m8
   GMI
                            The Devon Exchange System provides back-office processing
   octagon
   Devon                    requirements of firms participating in the European exchange-traded
   Global Margln Server     derivatives markets. Designed for smaller firms with low-end volume
   GDS Prklng Data          requirements, or for use as an adjunct to outsourced services,
   Worldsource              Devon is a powerful yet cost-effective solution with real-time
   Exchange Gateway         processing, full multi-currency account management and extensive
   AudlTrade                exchange-interface connectivity.
   AudlTtack
   Supported Exchanges
   Professional Servlces    Devon provides the ability to receive, process, and turn around trade
   Tralnlng/Documentatlon   information quickly, and is ideal for providing time-sensitive and
   Futures News             accurate trading information to multiple sources immediately after
   Industry Unks            market close. The system offers trade interface connectivity with a
   Futures Contacts
   Customer Lqln            stable and efficient processing platform for the clearing and
 Irbwwhlr                   settlement of exchange-traded futures and options and related OTC
                            contracts.
 PhaPs3
 Stream
                            Devon provides the following features and advantages:
ST84 ikttlcmcnt*
Wall St Concepts
                                   Option of registering trades directly and automatically from a
                                   trade source, such as an exchange matching system or third
                                   party trade interface, or by direct input

                                   Provides trade validation by a designated user to prevent
                                   incorrect or unauthorized entry of transactions into the live
                                   environment

                                   Interfaces with exchanges, SunGard's Worldsource, or other
                                   price vendors for contract settlement prices

                                   Ability to apply a range of limit controls to monitor
                                   transaction activities in volatile or tightly regulated markets

                                   General Ledger postings for double entry bookkeeping, which
                                   can be incorporated into a central GL accounting system
                                   within the organization

                                   Automatic generation of trade confirmation records, which
                                   can be output as customer stationary, altowing users to
                                   define fields, look and feel, size and proportion of
                                   information on each page

                                   Generates commission schedules, ranging from exchange
                                   fees and clearing commision, to clearing feas and floor
                                   brokerage

                                   Extensive and flexible reporting for customer stationary,
                                   regulatory reporting and information access; both standard,
                                   pre-defined reports, as well as ad hoc, user-specific reports

                                   Runs on MS Windows MT or 2000 operating systems, and is
                                   available as a stand-alone or networked system

								
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