1. Preservation of capital or return: an unavoidable choice?
May 2006
Preservation of capital or return: an unavoidable choice?
Justo de Rufino
BBVA Mercados Globales y Distribución
Director Negocio Crédito

2. Products with guaranteed capital
Product description
Structured Products
Investors seek
Products with guaranteed capital
Maximization of the Yield/Volatility Ratio

3. Structured products with guaranteed capital
Product description
Structured Products
Structuring ability
Maximum flexibility to meet client needs
Structured products with guaranteed capital

4. Annual/Quarterly Coupons (Fixed or floating)
Product description
Structured Products
Structured Products
100% Protected Capital
The client receives the yield by means of: +
Annual/Quarterly Coupons (Fixed or floating)
100% Dynamic Management

5. Structured products with guaranteed capital
Product description
Structured Products
Format
Flexibility
to meet
client needs
100%
Protected
Capital
Structured products with guaranteed capital
Dynamic
Management
Institutional
Tier I
Bonds
(PPN)
Annual/
Quarterly
Coupons
Notes with
guaranteed
capital
linked to
CDX
Dynamic
Management of
Basket
of Funds
(CPPI)

6. Format Structured products may have the following format:
Format: Notes Issued by SPV, Issuer, Deposit, Swap, etc
Term: 7/10 years
Protected Principal: 100%

7. Coupons
Structured Products
Annual/
Quarterly
Coupons
The product pays coupons annually or quarterly, either guaranteed or subject to the existence of a cushion in the structure:
Floating
Fixed
Benchmarked to some index, etc

8. Dynamic management of CPPI
Structured Products
Dynamic
Management of
Basket
of Funds
(CPPI)
Dynamic management is introduced into the structure, applying the CPPI technique (see section II for further details)
The underlying asset, dynamically managed, will be a basket of funds, chosen by means of a quantitative analysis, seeking to maximise the yield/risk binomial.
Research will be carried out with the aim of obtaining an asset with high yield, accompanied by very low volatility, thanks to the optimization achieved by the study of correlations between the components of the basket
By dynamic management, leverage, in addition to guaranteeing the nominal value, allows the share in the rise of the underlying asset to be over 100%

9. Dynamic Management of CPPI
Structured Products
Dynamic
Management of
Basket
Of Funds
(CPPI)
The asset underlying the CPPI will be a balanced, consistent basket of funds from the yield/risk ratio point of view.
We need to imagine a basket selected from among the following categories, with a track record showing an excellent level of yield/risk and a study of the basket’s correlation, sensitivity and trade-off which guarantees balance and diversification:
Underlying
Asset
Global Fixed Income
US Fixed Income
Global Equities
Latam Equities

10. Dynamic Management of CPPI
Structured Products
Dynamic
Management of
Basket
Of Funds
(CPPI)
Dynamic Management Simulation : we have carried out 1000 Monte Carlo Simulations using the following scenario:
Funding: 1M USD Libor forward.
Maximum Investment in the Underlying Basket of Funds: 300%.
Maximum Monthly Fall permitted: 10% (Leverage: 10 times the cushion).
Initial Cushion: [15.00]%.
Initial Investment: [150.00]%.
Coupon zero fixed at the outset to protect the capital.
Yield and Volatility of the Basket for carrying out the Monte Carlo simulations exactly as indicated in the Track Record:
IRR: 12.45%.
Volatility: 4.89%.
Simulations

11. Dynamic Management of CPPI
Structured Products
Dynamic
Management of
Basket
Of Funds
(CPPI)
According to the 1000 Monte Carlo Simulations that were carried out and the distribution of probabilities of the IRR of the CPPI over the nominal value of the notes, statistically:
The average expected IRR of the CPPI is 16.69%
The IRR of the CPPI will be over 10.52% with a 95% probability
The IRR of the CPPI will be over 7.61% with a 98% probability
Simulations

12. Dynamic Management of CPPI
Structured Products
Dynamic
Management of
Basket
Of Funds
(CPPI)
Simulations
Distribution of probabilities of the expected CPPI yield, to which must be added the yield received as a result of payment of guaranteed coupons, which in this case are annual coupons at 2.50%
Average IRR 16.69%
Percentile 95: IRR 10.52%
Percentile 98: IRR 7.61%

13. Notes with guaranteed capital linked to CDX
Structured Products
Notes with
guaranteed
capital
linked to CDX
Notes with guaranteed principal
Minimum coupon guaranteed
Additional coupon, linked to possible credit events in the 0% - 3% tranche of the CDX index.
Final Accumulated Super Coupon, linked to possible credit events in the 0% - 3% tranche of the CDX index.
Characteristics

14. Notes with guaranteed capital linked to CDX
Structured Products
CDX Index
Standard and liquid credit index (CDS)
Consisting of 125 references of US Investment Grade
Wide diversification by sector
0 – 3% Tranche: Equity Tranche of the CDX Index
Absorbs the first losses up to a limit of 3% of the portfolio (CDX)
0 – 3% Tranche

15. Notes with guaranteed capital linked to CDX
Structured Products
Structure
Throughout the life of the Note the Investor receives:
+ Guaranteed Coupon
+ Variable Coupon (linked to defaults in the 0% - 3% tranche of CDX)
Risk-free
Asset
Credit exposure
100% Capital
Super Coupon
Investment in CDX 0-3%
Investment in risk-free asset
At term the investor receives:
+ K Guaranteed
+ Super Coupon (linked to defaults in 0% - 3% CDX)

16. Notes with guaranteed capital linked to CDX
Structured Products
Flow structure
During 10 years the investor receives:
A minimum guaranteed coupon
A credit-linked coupon
At term he receives:
100% of his guaranteed investment.
A Final Super Coupon, also credit-linked.
Note at 10 years
Credit-linked Coupon
Guaranteed Coupon
Final Super Coupon
Guaranteed Principal
10 years

17. Notes with guaranteed capital linked to CDX
Structured Products
Flow Structure
Term : 10 years
Currency: USD
Minimum guaranteed coupon: 2.43%
Fixed coupon linked to CDX 0-3% : 3.94%
Final Premium Coupon linked to CDX 0-3% : 39.05%
IRR (in case of no defaults): 9.11%
Example
Number of defaults
Guaranteed Coupon
C.Linked Coupon
Premium Coupon
2.43%
3.94%
39.05% 1
2.43%
3.41%
33.84% 2
2.43%
2.89%
28.64% 3
2.43%
2.36%
23.43% 4
2.43%
1.84%
18.22% 5
2.43%
1.31%
13.02% 6
2.43%
0.79%
7.81% 7
2.43%
0.26%
2.60% 8
2.43%
0.00%
0.00%
Estimated Recovery Rate: 50%

18. Dynamic Management of Principal Protected Note (PPN)
Structured Products
Dynamic
Management
Institutional
Tier 1
Bonds
(PPN)
Format: Notes (PPN) issued by SPV
Dynamic Management: initial exposure of 250% of the nominal value issued in a bond portfolio made up of Institutional Tier 1 securities
A system of Triggers is set up, in other words, exposure and cushion limits that force disinvestment if the cushion descends to the level below. If it returns to the upper level, reinvestment takes place but never exceeding an exposure of 250% on the basket

19. Dynamic Management of Principal Protected Note (PPN)
Structured Products
Dynamic
Management
Institutional
Tier 1
Bonds
(PPN)
Portfolio
The underlying bond portfolio may have the following characteristics
Institutional Tier I securities
Basket made up of 20 references
Each bond in Asset Swap until the first Call date
Issuers with a credit rating between AAA y A+

20. Dynamic Management of Principal Protected Note (PPN)
Structured Products
Dynamic
Management
Institutional
Tier 1
Bonds
(PPN)
In case of the call being exercised on any bond by the issuer, or the rating of the issuer itself falling below Investment Grade, BBVA shall be able to substitute the bond(s) in question within the portfolio to protect the structure.
In such a case, the substituting bond shall be similar to the one being substituted and come from an issuer of the same rating or higher than that originally held by the issuer of the substituted bond in the structure.
Substitution
Event

21. Dynamic Management of Principal Protected Note (PPN)
Structured Products
Dynamic
Management
Institutional
Tier 1
Bonds
(PPN)
Dynamic Management Simulation:
Funding: 1M Euribor forward
Maximum Investment (Equal to the Initial Investment): 250%
Initial Cushion: [30.93]%
Open Coupon Zero
Quarterly Coupons: Euribor 3m + 20pb
Scenario presented:
At current market levels, the carry of the underlying bond portfolio is:
Euribor 1M pb
Carry (net of fees) of the leveraged underlying bond portfolio:
Euribor 1M pb
Simulations

22. Dynamic Management of Principal Protected Note (PPN)
Structured Products
Dynamic
Management
Institutional
Tier 1
Bonds
(PPN)
Result of the simulation:
IRR: 5.61% (quarterly coupons of de Euribor 3m + 20pb included in the calculation and net of fees)
Simulations
This IRR would improve if:
There were a rise in interest rates, because the return received by the client is at a floating rate and this would also make the product more consistent, avoiding the likelihood of a partial or total Trigger Event.
There were an improvement in the price of the bonds in the underlying portfolio.