International Portfolio & Risk Management Creative solutions by financial engineers

Derivatives Derivative = obligation to accomplish a transaction in the future Forward Contract = basic derivative from which all others have evolved Repurchase Agreements –Reverse Repurchase Agreements Futures Contracts

Derivatives Swaps –Futures and Forward Contracts On Swaps Options Currency Options –Swaptions –Options On Futures –Futures On Options

Floating-Fixed Swaps Fixed If net is positive, underwriter pays party. If net is negative, party pays underwriter. Illustration of a Floating/Fixed Swap Party Underwriter Counterparty Variable Fixed Variable

Floating to Floating Swaps LIBOR If net is positive, underwriter pays party. If net is negative, party pays underwriter. Illustration of a Floating/Floating Swap Party Underwriter Counterparty T-Bill LIBOR T-Bill

Parallel Loan United States Germany Loan guarantees Debt service in $ Illustration of a parallel loan German Parent U.S. subsidiary of German Firm U.S. Parent German subsidiary of U.S. Firm Principal in $ Debt service in Euro Principal in Euro

Currency Swap German rate x €1,000,000 € 1,000, U.S. rate x $1,500,000 German rate x €1,000,000 U.S. rate x $1,500, € 1,000,000 $1,500,000 € 1,000, $1,500,000 € 1,000,000 $1,500,000 Illustration of a straight currency swap Step 1 is notional Steps 2 & 3 are net Borrow in US, invest in Europe Borrow in Europe, invest in US

Swaps Investor Underwriter Libor ± Spread Equity Index Return* *Equity index return includes dividends, paid quarterly or reinvested Illustration of an Equity Return Swap

Swaps Investor Underwriter Foreign Equity Index Return* A Illustration of an Equity Asset Allocation Swap *Equity index return includes dividends, paid quarterly or reinvested Foreign Equity Index Return* B

Equity Call Swap Investor Underwriter Illustration of an Equity Call Swap Equity Index Price Appreciation* * No depreciation—settlement at maturity Libor ± Spread

Equity Asset Swap Underwriter Equity Index Return* * Equity index return includes dividends, paid quarterly or reinvested Income Stream Investor Income Stream Asset

IRRM Products Listed Products –Futures –Options Custom Products –Swaps –Caps –Floors –Collars

Caps Premium Client Underwriter Today *Payments are made periodically (say, monthly or quarterly) over the life of the contract, with rates appropriately adjusted for the number of periods per year Illustration of a 7% Interest Rate Cap on LIBOR Max[(LIBOR – 7%), 0] Underwriter Later* Client

Floors Premium Client Underwriter Today *Payments are made periodically (say, monthly or quarterly) over the life of the contract, with rates appropriately adjusted for the number of periods per year Illustration of a 3% Interest Rate Floor on LIBOR Max[(3% – LIBOR), 0] Underwriter Later* Client

Collars Premium Client Underwriter Today *Payments are made periodically (say, monthly or quarterly) over the life of the contract, with rates appropriately adjusted for the number of periods per year Illustration of a 3,7 Collar on LIBOR Max[(LIBOR – 7%), 0] + Max[(3% – LIBOR), 0] Underwriter Later* Client

Long Call S $ 0 - C X X+C

Short Call S $ 0 - C X X+C Long Call X S $ 0 X+C C

Long Put S $ 0 - C X X+C X S $ 0 C Long Call Short Call S $ 0 X - P X-P

Short Put S $ 0 - C X X+C X S $ 0 C Long Put Long Call Short Call S $ 0 X - P X-P S $ 0 P X

Long Straddle S $ 0 - C X X+C X S $ 0 C Long Put Long Call Short Call S $ 0 P X X-P S $ 0 X - P X-P Short Put S $ 0 X -(P+C) X-P-C X+P+C

Short Straddle S $ 0 - C X X+C X S $ 0 C Long Put Long Call Short Call S $ 0 P X X-P S $ 0 X - P X-P Short Put S $ 0 X -(P+C) X-P-C X+P+C Long Straddle $ 0 X P+C X-P-C X+P+C S