THE CAPITAL MARKETS

February 2004

1

IN TR O D U C TIO N This lecture presents the basic ingredients of the capital m arkets – their function, fram ew ork and im plem entation. It w ill define com m on m arket term s and surve y the fram ew ork and structure of ke y m arket sectors and com ponents. It w ill discuss the significance and developm ent

- The 32nd - The Curve 1) The Money Market - Libor - Swaps - Money Market Spreads

of these sectors and their inter-relationships. Exam ples and exercises w ill dem onstrate im portant characteristics of these sectors. The final goal is to

D) THE GOVERNMENT MARKET

- Treasuries

utilize all the ingredients as tools to construct and to analyze the structure, planning and pricing of a capital m arket transaction.

A) B AS IC S 1) Jargon – let’s define som e term s 2)“M aturity” and “S ecurity ”

B ) C AP IT AL M AR K E T S

- (N o M uni / N o E quity )

1) The Firm - B ankers – C orporate Finance - Trading and S ales - R esearc 2) C apital M arket The 415 S helf

C ) TH E C U R V E S - A F ram ew ork 1) The D aily P age - The C urves - The S preads - The N um bers 2) The Treasury M arket – G overnm ents

1) 2) 3) 4)

The Curve - “on the run” T-Bills and Liquidity Comparables (“comps”) - “off the run” Benchmarks and Pricing 5) “Did We Roll Yet” - the “WI” and Auctions

E) REPURCHASE AGREEMENTS – “REPO” 1) Ingredients - Collateral - Liquidity - Security and Maturity - “Mark to Market” Legal Test Financial Test 2) “Specials” 3) Reverse Repo

F) INTEREST RATE SWAPS 1) Why Swaps ? - Efficiency / Risk Leverage vs “Notional” 2) Swap Spreads 3) Swap Rates 4) Swap Indices 5) The Asset Swap 2

J)

G) TREASURY SUPPLY 1)

Where Did the Treasury Market Go ….And When Did It Come Back ? 2) What Happens When “Benchmarks” Disappear ? 3) Agencies

H)

CORPORATE BOND SUPPLY 1) History 2) By Category

I)

THE NEW ISSUE CORPORATE BOND 1) History - The Old Method - The Euro Market 2) Rule 415 - Brief History - S1,S2,S3 - 144A

THE NEW ISSUE DEAL 1)

The Goal of a Financing Raise Capital - Diversify Restructure Debt - Short vs Long - “Bridge” 2) The Deal - Ingredients - Strategy - Timetable 3) The Syndicate The “POT” and the “POT” System The Classic 50% POT Deal The New Style – The “GLOBAL” 4) Pricing - Strategy - “Housekeeping - Procedure - Hedging

3) Documentation - The Filing - The Prospectus - The Indenture - The Supplement The “Red” The “Final”

3

TERMS and CHRONOLOGY

4

Terms COUNTING BONDS

– $1000 = 1 bond / 1000 bonds $1,000,000.0

BASIS POINT

– .0001 = .01% = 1 basis point / “running” vs “up front”

YIELD VALUE of 32nd

= $312.50 per million – ALWAYS !!

LIBOR

– the “London inter-bank offered rate” / “libid” / “li-mean” / Sibor

EURIBOR

– the “Euro” interbank offered rate / EONIA

SPREAD

– “narrowing” “widening” “tightening” “credit” Issue credit spread + benchmark yield = yield @ $ price

YIELD

– “to maturity” “current” “DM” for FRN’s

DISCOUNT / COUPON

– different expressions of YIELD

DAY COUNT

– 30/360 / actual/360 / actual/actual

COUPON PAYMENT TYPE – annual / semi-annual / quarterly / monthly FIXED vs FLOATING

– “variable”

FRN vs FIXED COUPON

FED FUNDS

– vs “clearinghouse” check vs cash “next day vs same day”

SETTLEMENT

– time and type / “DVP” - delivery vs payment” TYPE - physical / book-entry (BE) – global / DTC / Euro Clear TIME - “cash” / “regular” / “skip” / “corporate” / (T + 1, 2 or 3 )

BOND / NOTE / BILL

– Maturity reference CD, CP, BA

REPURCHASE AGREEMENT – “Repo” a “buy / sell” security agreement / a loan 5

MONEY MARKET

– under 1 year / under 2 year / “2 A -7” (13 mth)

GOVERNMENTS

– U.S. treasuries - NOT sovereigns

ABS

– asset-backed securities

MORTGAGES

– CMBS, single-family, GNMA

DERIVATIVES

– swaps, credit default - essentially any security gaining or maintaining or deriving its value from another security or the performance of another security

YANKEE / EURO / GLOBAL

– “Samurai”, “Bulldog”, “Dragon” -currency and geography

PUBLIC / PRIVATE

– “registered” / “144a” / “144a with “reg rights”

CURVE

– the “run” / “on” and “off” the curve / “comps” / “benchmark” / “swaps”

SWAP

– security swap (switch) / interest rate swap

CREDIT DERIVATIVE

– the “default market” 5yr Libor

“CDO” / “CLO”

– collaterlized debt obligation / collaterlized loan obligation / “structure”

REGISTRATION

– “distribution” vs “ownership” – 415 shelf “continously” offered or “available”

SOVEREIGN / SUPRA-NATIONAL

– foreign government, government owned or multi-lateral

EMERGING MARKETS

– generally below investment grade sovereign and corporate credits

COMMERCIAL PAPER

– “unsecured promissory note”

MUNICIPAL

– tax - exempt

EQUITY

– stocks

FIXED INCOME

– debt 6

MATURITY - Chronology 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

FEDERAL FUNDS REPURCHASE AGREEMENTS - “overnights” “term” TIME DEPOSITS (Domestic and Euro) “TD’s” COMMERCIAL PAPER “CP” BANKER ACCEPTANCES “BA” CERTIFICATES of DEPOSIT “CD” EURO CD TREASURY BILLS 1 YR NOTES (MTN’s / FRN’s / FRA’s) ASSET-BACKED SECURITIES SHORT NORES (2YR – 5YR) Gvt, Corps, Agencies INTERMEDIATES (5YR –10YR) Gvt, Agency, Corps, Mtgs LONG BONDS (12YR or longer…

SECURITY - Safety 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

FED FUNDS T-BILLS GOVERNMENTS REPURCHASE AGREEMENTS “GC” ONLY BA’s CD’s (“Euro Question”) AGENCIES (not all) ASSET-BACKED SECURITIES MORTGAGES CORPORATES COMMERCIAL PAPER 7

THE FIRM

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THE FIRM Debt / Fixed Income

Research

Investment Banking Corporate Finance

Banking

Trading

M&A Debt Capital Markets Equity Dept

Economic Market Credit Specialty

New Issues Derivatives

Syndicate

Swaps

Tax Structures F/X

F/X Derivatives Ratings

New Issues Re-openings Med Term Notes Stabilization

Trading Governments Agencies Money Markets

Mortgages ABS Corporates Derivatives Credit Derivatives

Sales Governments Money Mkts

Mortgages Corporates Inv. Grade

Derivatives Middle Mkts ABS

Swaps

Financing Desk

Credit

No Muni / No Equity

Trading and Sales

Emerging Mkts

High Yield 9

THE CURVES

10

“THE DAILY” UST 1 1.14 18 1.43 2 1.70 3 2.23 4 2.65 5 3.01 (05) 7 3.52 10 4.03 “BILLS” 30 4.89

SWAP 1.38 1.70 2.00 – 04 2.58 – 62 3.03 – 07 3.39 – 43 3.91 – 95 4.41 – 44 5.18 – 22

88 – 89

6.

3.29

2– 5

+ 131

3

92 – 93

8.

3.74

2 – 10

+ 233

6

99 – 1.01

9.

3.88

2 – 30

+ 319

5 – 10

+ 102

10 – 30

+ 86

REPO FF 96 – 1.00 O/N 1.00 – 95 7 1.00 – 97 15 99 – 43 30 99 – 94 60 90 .

YLD CRV SPRDS

CP A-1

1.10 – 05

30 – 34 34 – 38 41 – 45 38 – 42 50 – 53 38 – 42 30 – 33

.

1

.

LIBOR 1.10 1 1.07 2 1.09 1.13 3 1.10 4 1.13 5 1.15 6 1.18 9 1.28 12 1,42 3 X 1.09 MMKT SWAPS 6 X 1.13

A-2 98 –

1.16 – 11 1.17 – 06 1.17 – 06

88 – 1.00 – 98 1.02 – 99 1.03 – 00 1.03 – 00 1.03 – 00

1.36 – 1.42 – 1.42 –

.

.

. 11

TREASURER’S PAGE

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Treasurer’s Page • Fed Funds • T- Bills • Repo Rates • Treasuries • Currencies • Swaps • Stock Indicies • LIBOR • Futures • MBS...

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“DIRECT ISSUE” COMMERCIAL PAPER A-1 / P-1

A-2 / P-2 and A-3’s

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MONEY MARKET “DERIVATIVES”

“OVERNIGHT” FED FUNDS SWAP

“MONEY MARKET” SWAPS “Fixed” vs 1 Month LIBOR

FLOATING RATE AGREEMENTS “Delayed Start” Floaters

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LIBOR “FIXING” When: 11:00 AM London GMT Who: BBA - British Bankers Association Key “Fixings” 1 Mth LIBOR 3 Mth LIBOR 6 Mth LIBOR Note the various currencies...

16

LIBOR

LIBID

LIBOR

17

Combination “STRIPS”

1YEAR “LIBOR” or swap yield 18 Mth “LIBOR” or swap yield

30 /360 = “Bond Yield” semi–annual interest” paid on coupon dates

ACT / 360 = Money Market Yield “interest at maturity” 18

AGENCY DISCOUNT NOTES

…tends to set “lower limit” on money market pricing...

19

T – BILLS 1 MONTH 3 MONTH 6 MONTH • Quoted on “discount”

basis • “bond equivalent” or “coupon yield” also quoted

NOTE: “WI”

20

T-BILLS (no coupons)

21

Low Rates… “liquidity preference” outweighed by yield preference..

22

“On The Run” 2yr

23

“On The Run” 3yr

24

4 YEAR “COMP” 2.65 YIELD

“On The Run” 5yr

“WI” 5 YEAR Trades in “yield”

25

7 Year “COMP” 3.52% Yield

10 YEAR “On The Run”

10 YEAR “WI”

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THE TREASURY MARKET • • •

“ON THE RUN” “COMPS” MY FRIEND THE “32 nd”

=

$312.50 ALWAYS!!

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THE TREASURY CURVE

THE ROLL

“ON THE RUN” 2YR, 3YR, 5YR, 10YR, 30YR

“ WI” “WHEN ISSUED” 5YR - QUOTED IN YIELD

THE ROLL – 3.009 vs 3.04 “CASH BID” vs “WI” OFFER

“Forward & Reverse” quoted +4.25 / -400

TREASURY BILLS 1 MTH, 3 MTH, 6MTH

NOTE: 30YR 5.375 2/31 “HIT” @ 107.090 = 107 + 9/32 3YR 2.25 2/07 “100.01+ - 016 “ = 100 + 1/32 BID – 1/32 + 3/4 of 1/32 ( 3 “64th” ‘s)

“+” = 1/2 of 32nd (“64th”) “2” = 1/4 of 32nd (“128th”) “6” = 3/4 of 32nd “1” = 1/8 of 32nd (only 2YR Notes) “3” = 3/8 of 32nd “7” = 7/8 of 32nd

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THE TREASURY CURVE

“OLD 3 YEAR” 101.123 “BID” = 101-12 and 3/8’s = 101 + 12 32nd’s + 3/8 of a 32nd = $1,010,000 + $3,750 + $117.19

1 MILLION BONDS = $1,013.867.19 + “accrued interest”

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$ Value of a Basis Point an (“01”)

A 32nd always equals $312.50

ALWAYS !!

1 YR bp = $100 3 bps = $300 32nd = $312.50

1 Year

@ 1YR… ... 32nd = 3.046 bps

Value of bp Yld Value of 32nd

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1 bp = $1.9166 32nd = 1.631 bp @ 2.25% 2/15/07

1 bp = $288.00 32nd = 1.085 bps

Old “shortcut”... ...@ 4YR 1bp = 32nd not anymore !

@ 6.25% 2/15/07

1 bp = $308.16 32nd = 1.014 bp

...Now close to 3Yr

“TIPS” inflation linked notes

Value of bp Yld Value of 32nd

“Callable”

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Value of bp Yld Value of 32nd

1 bp = $1,249.80 1/8 on $1MM = $1,250 32nd = .25 % = 1/4 bp 4 x 32nd = 1bp 4 x 32nd = 1/8 point 1/8 = $1,250 1 bp = $1,250

32

Value of bp Yld Value of 32nd

1 bp = $1,551.30 32nd = approx 1/5 of bp 1 bp = approx 5 X 32nd = 5 X $312.50 = $1,562.50

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THE REPO MARKET “HOW A GUY NAMED VINNY AND HIS BUDDY SAL CHANGED THE WORLD”

34

The Financing Desk • Insures liquidity of Firm by “funding” the Firm • Runs the “matched book” • Finances the “positions” of the Firm by using the “repo Market” Debt – UST, agencies, ABS, mortgages, corporates Equity Foreign Exchange Money Markets – CP, CD’s Bank Liquidity – Time deposits (TD’s, “depo’s”), CP, CD’s

Repurchase Agreement – “Repo” / “Reverse Repo”

FOLLOW THE MONEY !!

- “repo” market

REVERSE REPO

“MATCHED BOOK” REPO

1 wk “GC” = 1.01 / .95 - Dealer “buys collateral @ 1.01% - Dealer “sells” collateral @ .95%

DEALER – “buys” collateral / “sells” money (receives) (delivers) CLIENT – “sells” collateral / “buys” money (delivers) (receives) DEALER – “sells” collateral / “buys” money (delivers) (receives) CLIENT – “buys” collateral / “sells” money (receives) (delivers)

earns 1.01% interest pays 1.01% interest

pays .95% interest earns .95% interest 35

“BID” for “GC” “general collateral” THE “REVERSE REPO”

“OFFER OF “GC” THE “REPO”

Other types of collateral… agencies mortgages corporates

36

REMEMBER: The market for 7day “GC” is 1.00/.95

“Old 3 YR is “very special”

SPECIALS

SPECIALS – Specific issues worth more as its “specific issue” than as “GC” are SPECIAL 37

“SPECIALS” NOTE the large variations in pricing… Most of the pricing volatility is due to the auctions… There is a scarcity of these two issues going into the auctions… Why ? Because they have been “shorted” as a result of auction strategy and there is specific demand for these issues Must deliver to get paid….

VERY SPECIAL

38

REPO UST 6.50 10/06

DEALER

“ COLLATERAL ”

CLIENT 1 wk “GC” market = 1.01 / .95

“pays interest”

CASH

“earns interest”

“GC” RATE .95% DEALER EARNS “ CURRENT YIELD ”

UST 6.50% @ 111- 14+ = 2.02 YTM CURRENT YIELD = approx 5.83%

REPO TRANSACTION DEALER EARNS “ CURRENT YIELD “ 5.83% LESS “ GC “ RATE .95% “ POSITIVE CARRY “ 3.88 bps

Remember: DVP

REVERSE REPO (“Special”) REVERSE RATE .15% Dealer “short” 3.25% CPN

DEALER “receives interest”

CASH “ COLLATERAL ”

CLIENT

“SPECIAL” MARKET 3.25 1/09 = .15 / .05

“pays interest’

UST 3.25% 1/09 • UST 3.25% 1/09 @ 101-03 = 3.01% “YTM” • = CURRENT YIELD 3.19% • “REVERSE REPO” RATE = .15% (15 bps) DEALER: - 3.25% COUPON SHORT + .15% REVERSE RATE - 3.10% COST OF SHORT + LOSS OF TIME / MONEY FOR NUMBER OF SHORT DAYS

CLIENT: +3.19% - .15% 3.04% + .95% 3.99%

CURRENT YIELD “COST OF MONEY” INVESTMENT RETURN (1wk “GC” rate = .95%) CLIENT RETURN 39

AUCTIONS

Estimated “roll”

“special” equals demand

New 3Y note The new 3Y note, maturing on 15-Feb-2007, will be auctioned on 10th February. We anticipate an issue size of $24 bn, and estimate a fair value for the roll at pick 15.75 bp (for value as of announcement date). We use our spline model to estimate a fair value for the roll, by first calculating a yield for the WI issue using the spline, and then fixing the amount of premium attributable to the WI issue (a spread to the spline). The amount of the premium factors in the benchmark status, as well as current market supply and demand considerations. Using a spline yield allows us to account for curve extension, as well as coupon differences, and allows us to compare cycles of issuance in different yield curve and slope environments, without the level distortions inherent in raw yield spreads. Taking this analysis one step further, the spread to the spline for any particular issue incorporates a certain amount of premium, or financing-adjustment, driven by supply and demand considerations in the market. We can

distortion, we need to strip out this financing-adjustment to be able to compare previous cycles on a like-for-like basis. This then gives us a cleaner estimate of how much of a benchmark premium a new issue is likely to command. Note that in terms of actual valuation for WI issues though, we would need to add back a financingadjustme estimate, based on where we believe the WI issue is likely to trade in the repo market. Exhibit 4 shows the financing-adjusted spline spread for the current 3Y note, as well as the previous 2 issues

.

40

Adjusting for “repo” cost

“CARRY”

We see that the recent 3Y notes have been priced at around 0.5-2.5 bp cheap to the spline, and have tended to richen in the following months. However, the current 3Y note is currently slightly cheaper than the previous two issues, for this point in the cycle, and as such we would expect the WI 3Y note to trade on the cheaper side of the range. Hence, we estimate a financing-adjusted spline spread for the WI of about 2 bp cheap to the curve. Also, we believe the WI issue is likely to trade about 25 bp through GC in the repo market, which equates to a financing-adjustment of about 2.2 bp (to next auction New note settle5Y date). The new note, spline maturing 15-Feb-2009, willestimate be Given the5Y closing yield at 2.457%, we auctioned on 11th February. We anticipate an issue size of a $16 bn, of and estimate a fair value the roll at pick 5.75 fair roll +15.75 bp, for value as for of announcement bp (for value as of announcement date). date Exhibit 5 shows theonrecent 5Y notes have been (with the forwardthat yield the current 3Y at 2.283%, priced as of at around 1-3 bp cheap to the spline model, on a financing-adjusted the 3Y current Thursday’s close). basis. Carry shows on the that current note issuance should regime the would in an2.6 issuance shortfall narrow rollresult by about bp to first settle.of about $119bn, if the CBO deficit projections are realized.

We estimate that the WI 5Y note will trade at a financingadjusted spline spread of about 1.5 bp cheap to the curve. Also, we believe the WI issue is likely to trade about 35 bp through GC in the repo market, which equates to a financing-adjustment of about 0.6 bp (to next auction settle date). Given the closing spline yield at 3.262%, we estimate a fair roll of +5.75 bp, for value as of announcement date (with the forward yield on the current 5Y at 3.213%, as of Thursday’s close). Carry on the current 5Y note should narrow the roll by about 2.1 bp to first settle. 41

New 10Y note The new 10Y note, maturing 15-Feb-2014, will be auctioned on 12th February. We anticipate an issue size of $17 bn, and estimate a fair value for the roll at pick 4.5 bp (for value as of announcement date).

Exhibit 6 shows the financing-adjusted spline spreads for the current 10Y note as well as the previous 4 10Y cycles (since the switch to quarterly issuance). We see that both the 08/13 and the 11/13 cheapened against the spline at the time of the re-opening. We estimate a financing-adjusted spread of 7.5 bp rich to the spline. Also, we believe the WI issue is likely to trade about 30-35 bp through GC in the repo market, which equates to a financing-adjustment of about 1 bp (to May auction settle date). Given the closing spline yield at 4.33%, we estimate a fair roll of +4.5 bp, for value as of announcement date (with the forward yield on the current 10Y at 4.199%, as of Thursday’s close). Carry on the current 10Y note should narrow the roll by about 1.6 bp to first settle. Note that bad end days on the WI issue is worth about 0.3 bp.

42

TREASURY SUPPLY “WHO STOLE MY 3YR NOTE…AND BROUGHT IT BACK !”

43

TREASURY AUCTIONS 2 YR

NOTES

SINCE 1950

MONTHLY

UNCHANGED REDUCED / ENLARGED

3 YR

NOTES

SINCE 1950

QTLY

GONE 5/98 – BACK 1/’03

4 YR

NOTES

SINCE 1950

QTLY

GONE 12/90

5 YR

NOTES

SINCE 1950

QTLY

QTLY TO ‘91 MTHLY TO ’98 QTLY TO ’00 SEMI TO 1/03

W / REOPENINGS

7 YR

NOTES

SINCE 1966

QTLY

GONE 4/93

10 YR

NOTES

SINCE 1950

QTLY

SEMI-ANNUAL W / REOPENINGS

15 YR

NOTES

20 YR

NOTES

SINCE 1981

QTLY

GONE 1986

30 YR

NOTES

SINCE 1950

QTLY

GONE 2002

1 YR

T-BILL

SINCE 1973

MTHLY

GONE 2002

“Quarterly Refunding”

3 TIMES ONLY

GONE 1980

44

45

THE SWAP MARKET “OBJECTS IN THE MIRROR ARE CLOSER THAN THEY APPEAR” OR

“…PAY NO ATTENTION TO THAT MAN BEHIND THE CURTAIN”

46

SWAPS “bid” = “pay” fixed “ask” = “receive” fixed …always 3mth LIBOR

NOTE: 7 YR UST 5.00% 2/15/11 YLD = 3.52% 7 YR “Comp Benchmark YLD = 3.52% 7 YR SWAP “interpolated” YLD = 3.418%

…This is a difference of 10 bps in YLD

SWAP SPREAD BID / ASK “on the run” Benchmark Treasuries

TREASURY (UST) CURVE /YIELD the “interpolated curve”

SWAP YIELDS UST “interpolated curve” + SWAP SPREAD

MUST DEAL IN SWAP YIELDS NOT IN SWAP SPREADS 47

5 YR LIBOR Swap Sprd = 38 / 42 5 YR Swap Yld = 3.39 / 3.43 3 Mth LIBOR = 1.13%

5 YR UST Yld = 3.01 5 YR Issue Sprd = 85 bps 5 YR Security Yld = 4.01 3.39 (3.01 + 38) FIXED

“PAYS FIXED”

DEALER

“RECEIVES FIXED”

ISSUER

FLOATING

“RECEIVES FLOATING”

ISSUES

“PAYS FLOATING”

Fixed 3.89% +85

3 Mth LIBOR “FLAT”

ISSUER PAYS FLOATING RATE

3MTH LIBOR +50

3.89% - 3.39% = 50 bps

3 Mth LIBOR “FLAT” “PAYS FLOATING”

FLOATING

DEALER

“RECEIVES FLOATING”

ISSUER

FIXED

“RECEIVES FIXED”

3Mth LIBOR +55

“PAYS FIXED”

3.43 (3.01 +42)

ISSUER PAYS FIXED RATE

ISSUES

3.98% (3.43% +55bps = 3.98%)

ASSET SWAP

BUYER OWNS 4.64% “Asset” “PAYS FLOATING”

FLOATING

DEALER “RECEIVES FIXED”

“RECEIVES FLOATING”

BUYER FIXED 3.43 = 3.01+ 42

BUYER “EARNS” FLOATING RATE

3Mth LIBOR +128

“PAYS FIXED”

LIBOR +121 bps (4.64% - 3.43% +121bps) 48

7 YR LIBOR Swap Sprd = 49.5 / 53.5 (49 /54) 7 YR Swap Yld = 3.91 / 3.95 3 Mth LIBOR = 1.13%

7 YR (UST 5.00% 2/11) Yld = 3.52 7 YR Issue Sprd = +100 7 YR INTERPOLATED UST Yld = 3.418% (3.42)

Difference = 10 bps

“PAYS FIXED”

DEALER “RECEIVES FLOATING”

3.91% (3.42 +49) FIXED FLOATING

“RECEIVES FIXED”

ISSUES

ISSUER “PAYS FLOATING”

Fixed 4.52% +100

3 Mth LIBOR “FLAT”

ISSUER PAYS FLOATING RATE

3MTH LIBOR +61

4.52% - 3.91% = 61 bps

“comps” vs “on the run” WRONG “PAYS FIXED”

DEALER “RECEIVES FLOATING”

Treasury + Swap Spread

4.01% (3.52 +49) FIXED FLOATING

“RECEIVES FIXED”

ISSUER “PAYS FLOATING”

ISSUES

Fixed 4.52% +100

3 Mth LIBOR “FLAT”

ISSUER PAYS FLOATING RATE

3MTH LIBOR +51

4.52% - 4.01% = 51 bps

49

SWAP AND FLOATING RATE TERMS INDEX FED FUNDS

RESET DAILY (AVG)

“OPEN”

PAY MONTHLY (QUARTERLY)

“EFFECTIVE”

LIBOR MONTHLY

MONTHLY

MTHLY / QTLY

QUARTERLY

QUARTERLY

QUARTERLY

SEMI-ANNUAL

SEMI-ANNUAL

SEMI-ANNUAL

WEEKLY (AVG)

MTHLY/QTLY

DAILY (AVG)

MTHLY/QTLY

T-BILL PRIME RATE OTHERS CP – COMMERCIAL PAPER

USUALLY “MTHLY RESET/ MTHLY PAY

COFI – “COSTT OF FUNDS” IDEX (11th DISTRICT) CMT – “CONSTANT MATURITY TREASURY”

RESET and PAYMENT DATES

INTEREST DETERMINATION DATES

- 2 LONDON BUSINESS DAYS

- FED H15 - TELERATE 3750 - BBA PAGE

50

MONEY MARKET INDEXED SWAP RATES

PRIME RATE (4.00%)

T– BILLS

LIBOR

FED FUNDS

ALL INDICES ARE vs 3 MONTH LIBOR

51

CORPORATE BOND MARKET SUPPLY SECTORS TRENDS

52

Rating Scales S&P

A-1+

Long - term rating

Only in exceptional circumstances

Short-term rating A-1 A-2 A-3

AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BCCC+ CCC CCCCC C D

Moody's Short-term rating P-1 P-2 P-3 N.P.

B

Long - term rating

General correlation of short term and long term rating

Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C

Investment grade ratings

High yield grade ratings

Note: N.P. = Not prime Source: S&P & Moody’s

53

54

55

56

57

58

59

60

61

62

63

THE NEW ISSUE CORPORATE BOND MARKET •

D0CUMENTATION

•

REGISTRATION

•

414 SHELF

•

PUBLIC – PRIVATE (144A)

“ MTNs ”

64

DEBT REGISTRATION and “OFFERING” MATERIALS The 415 Shelf • 1981 • S-1, S-2, S-3 (F-1, F-2, F-3) • “Schedule B”

•Basic Ingredients • Indenture – contract between issuer and trustee on behalf of securities holders – creates the debt securities and “covenants” to protect investors – filed with SEC / not distributed to investors • Registration Statement – disclosure document – filed with the SEC and distributed to investo – Prospectus – the “base” / primary offering document • Underwriting Agreement – purchase or distribution contract between issuer and underwriters Underwritten Syndicate Offering Base Prospectus Preliminary prospectus (“red herring”) The “final”

Medium-Term Notes Base prospectus Prospectus supplement Pricing supplement (“pricing sticker”) 65

NOTE: Confidential Offering Memorandum N0 “Red Herring” Description

Final Pricing Fees

No Registration 4(2) 144a

“LEADS”

Co- Mgrs Jr Co’s 66

More Information than “registered” deal

67

“Boilerplate” …do’s and don’t’s

68

69

“make - whole” call

Using “144A” exemption until “SHELF” filed... • Timing • Penalty

70

“denoms”

71

Syndicate participation breakdown. Only in FINAL …not in preliminary or “red herring”

72

“Rule 144A “ selling restrictions - QIB’s

73

Last Page

74

“prospectus” date date of “shelf”

“supplement” – “off the shelf”

“sole” Lead Managed “supplement date is “offering date”

75

76

Company Information

77

NON-CALL

use of proceeds

78

“Company Disclosure”

79

The ability to issue the securities is contained in the broad “description” in the “prospectus”

The amount of the offering… this amount will be subtracted from the registered amount of the “shelf”

“coupon dates’

The details...

“record dates”

“Book-Entry” “global notes”

80

The “shelf”… note that this shelf incorporates the ability to issue several different types of securities… a “universal” shelf

shelf amount

date of shelf

81

Broad description of authorized types of securities able to issued. The specific details of each issuance will be spelled out in the “prospectus supplement”

“coupon dates”

82

Book-entry ability is specified in shelf… It actually flows from the “indenture”

83

“Underwriters,” “dealers” and “agents” (‘MTN’s”)

84

NEW ISSUE SYNDICATE “THE DEAL” •

MECHANICS

•

STRATEGY

•

TIMING

•

HEDGING

85

THE DEAL Initial Considerations TIMING

SIZE

MATURITY

Pricing

STRATEGY

Issuer Schedule / “Roadshow” “Investor Call Hedged (?) “Clear Space” - weekends / holidays / auctions / Fed Tranching Currencies Balance (Fixed / Floating) Demand / Supply Swap / Fixed …Cost of Money “Use of Proceeds” Credit rating (stable ?) Comparables “Secondaries” General market tone Recent Deals (supply ?) Curve Adjustment Sizing Strategy Specific / Non-Specific Sizing Question …Upsize ? International Participation – Announcement Timing 86

THE SCHEDULE 1.

Announcement - Formal ?

2.

Choose and Notify Syndicate - Dealer role Issuer role

3.

Road Show - Formal - schedule - teams Bloomberg / Internet Physical - “one on ones” / “telephonics”

4.

Initial Price Guidance

5.

“Revised” Price Guidance

6.

Investor Call - (Q & A) / “Cancelled”

7.

Launch - Final Size and Spread

8.

Allocation - Issuer Involvement

9.

Pricing - Hedging / Swap

10.

“Free to Trade”

11.

Stabilization 87

88

SYNDICATED DEAL THE CLASSIC - $1BILLION 10YR 50% “POT” With 1 Lead Mgr & 4 Co-Mgrs

DEALER DEALER DEALER DEALER DEALER

DB (LEAD) ML (CO-MGR) GS (CO-MGR) MS (CO-MGR) SB (CO-MGR)

UNDERWRITING 20% ($200MM) 20% ($200MM) 20% ($200MM) 20% ($200MM) 20% ($200MM) 100% ($1000MM)

RETENTION $100MM $100MM $100MM $100MM $100MM $500MM

POT $100MM $100MM $100MM $100MM $100MM $500MM

• Lead Mgr sells $100MM (own retention) + $500MM “POT” ($600MM) • Co-Mgrs each sell $100MM retention ONLY (can bring POT orders) FEES FEE BREAKDOWN

Management Fee Underwriting Fee Selling Concession Total Fee (“Gross”)

$1.30 $1.20 $4.00 $6.50

Total Deal Fees $6.50 X 1MM (1MM bonds = $1Bln) = $6,500,000 Each Mgr (5) 100MM Retention x $6.50 = $650,000 100MM “POT” x $1.30 = $130,000 100MM “POT” x $1.20…. = $120,000 Each Co-Mgr TOTAL = $900,000 $900,000 X 5 Mgrs = $4,500,000 500,000 bonds X $4.00 (selling concession) = $2,000,000 TOTAL FEES = $6,500,000 “DESIGNATIONS”

/ “SOFT DOLLARS”

/ LEAD 50% - 70% 89

THE GLOBAL- THE NEW SYNDICATE “100% POT” / “FIXED ECONOMICS / JOINT LEADS ECONOMICS Joint-Leads (2-4) (Book Runners) Co-Leads (3-5) (Senior) Co- Managers (5-10) (Junior)

80% – 90% 5% – 15% 1% – 5%

FEES ”GLOBAL” $4.50 x $1bln = $4,500,000

LEADS /BOOKS Joint-Leads / Joint Books = “League Tables” Other “Leads” %/$ smaller / No League Table

No Retention No Allocation No Designation No “Soft Dollars” Less Client Contact Same “Underwriting Risk”

Smaller Fees Bigger Deals More Participatio Less Work Less League Table Less “Deal Risk” 90

NEW ISSUE SYNDICATE PRICING Pre-Pricing Preparation 1. Book Reconciliation 2. “Dates”

- settlement date (T+3) (T+5) - maturity date – no weekends / holidays

3. “Billing and Delivery” 4. Allocation – “No Cry Babies!!” 5. Hedging and Hedge Ratios – the “Drop” 6. “Pricing Call” Roles Set 7. Set Coupons - Price @ discount - “long or short first”

PRICING -New DCX To Settle 1. Establish benchmark “bid side” dollar price ALWAYS “bid side” yield 2. Execute hedges 3. Add “pricing spread” ( +

)

4. Use new issue yield to calculate new issue price 5. Cut-up hedge; set opening stabilization strategy: set opening bid 6. Send “pot” lists 7. “Free to trade” 8. Cover “short” / stabilize

91

“SECONDARIES”

92

“SETTING THE TREASURIES”

“RISK”

93

PRICING THE NEW NOTE

“RISK”

94

THE “DROP”

95

DCX issues $ 1 Billion 5.70% 3 /13 / 2014 Final Deal Spread…………………….. +170 bps UST Benchmark (10 YR Note)……… 4.25 11 / 15 / 20013 Benchmark Dollar Price ……………... 101-25+ Benchmark Yield ……………………… 4.025% New DCX Note Yield………………….. 5.725% (4.025 + 170bps) Dollar Price on New DCX Note……… 99.803 (“5.70’s at 5.725 Yld”) New DCX Note Maturity………………. March 15, 2014 First DCX Coupon Date………………. September 15, 2004 (“long first”)

DCX “”HEDGING” Benchmark “RISK” Factor……………. 8.089 New DCX “RISK” Factor……………... 7.57 HEDGE RATIO………………………... .9358 (.936)

THE “DROP” Normal Benchmark Settlement……… February 12 “REGULAR” (NEXT DAY) Normal DCX Note Settlement……….. February 16 “CORPORATE” (T +3) Holiday !! Now February 17 Benchmark financing adj.(“repo cost”) .75 bps Cost of Settlement Difference for Sellers of UST vs New DCX…….. “THE DROP” = 1.5 32nd’s (.6 bp) REPO COST !!)

96