Module Handbook

DERI VATI VE APPLI CATI ONS
SMM503
Spring Term 2012
Nick Motson
n.e.motson@city.ac.uk
Mondays 12:00-15:00
Room LG001

Derivatives Applications
Term I I 2012

Lecturer: Dr. Nick Motson
Office: 4072
Phone Number: 0207 040 4074
Skype: nick.motson
E-Mail: n.e.motson@city.ac.uk
Office Hours: Monday 10:00 - 12:00 & Thursday 16:00 18:00

Course Overview and Objectives
The aim of the course is to develop students' understanding of derivatives,
particularly forwards, options and swaps in both vanilla and exotic forms. A
strong emphasis will be placed on the use of derivatives in practical applications
including risk management and structured products. The students will make
extensive use of Bloomberg and gain practical experience of the process of
designing structured products.

Course Materials
Hard copies of the slides and readings will be distributed in class each week;
they will also be posted on Moodle in a timely fashion.

Assessment
There will be one assessed coursework (25% of the final grade) and a written
exam (75% of the final grade).
The coursework will be assigned in week 5 and will be undertaken in groups of
up to 5 students. The deadline for submission is 4pm Tuesday 19
th
March
2012 (week 9).
The exam will last 2 hours and consist of 5 essay questions from which students
will have to answer three.

1
Lecture Schedule

Lecture 1
Introduction to Derivatives, Pricing Forwards & Futures

Lecture 2
Introduction to Options, Binomial Model, Black Scholes Model & Option Strategies

Lecture 3
Advanced Options & Exotic Options

Lecture 4
Introduction to Structured Products, Equity Structured Products

Lecture 5
Advanced Equity Structured Products

Lecture 6
Presentation by either J .P. Morgan Structured Products or Citi Private Bank
Structured Products (to be confirmed)

Lecture 7
Commodity Derivatives & Commodity Structured Products

Lecture 8
Interest Rate Derivatives & Structured Products

Lecture 9
Foreign Exchange Derivatives & Structured Products
+ Structured Products on Funds (traditional & hedge fund)

Lecture 10
Review of Coursework & revision of weeks 1 to 9 for exam.

Books

No one book covers everything in the course. We will make extensive use of
industry articles & term sheets that will be provided at each lecture and posted
on Moodle.

In lectures 1-3 I will refer to Options, Futures, and Other Derivatives by J ohn
Hull. There are lots of copies of this in the library; however it is considered as
the bible for derivatives so you might consider purchasing it.

The best book I have found on structured products is How to Invest in
Structured Products A Guide for Investors and Asset Managers by Andreas
Blumke. Though 45 full price, it is available on Amazon for 31.50. The library
also has loan and desk copies available as well as an e-book.
2
Lecture 1 Lecture 1
"We try to be alert to any sort of mega-catastrophe risk, and that posture
may make us unduly appreciative about the burgeoning quantities of long-
term derivatives contracts and the massive amount of uncollateralized
receivables that are growing alongside. In our view, however, derivatives
are financial weapons of mass destruction, carrying dangers that,
while now latent, are potentially lethal.
Warren Buffett's 2002 annual letter to Berkshire Hathaway shareholders.
Derivative Applications 2012
Nick Motson
1
3
DERIVATIVE DEFINITION
The word derivative originates from mathematics and
refers to a variable, which has been derived from
another variable.
Derivatives are so called because they have no value of
their own. They derive their values from the values of
some other assets, which is known as the underlying.
Examples of derivatives are forward contracts, future
t t d t t d ti t t Th
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2
contracts and swap contracts and option contracts. The
history of derivatives is quite colourful and surprisingly
longer than most people think!
A BRIEF HISTORY OF DERIVATIVES IN
5 SLIDES
Approx 1700 B.C.
J acob purchased an option costing him seven years of labour
that granted him the right to marry Laban's daughter Rachel.
Hi ti f th i l h d h His prospective father-in-law, however, reneged, perhaps
making this not only the first derivative but the first default on
a derivative. Laban required J acob to marry his older daughter
Leah. J acob married Leah, but because he preferred Rachel, he
purchased another option, requiring seven more years of
labour, and finally married Rachel, bigamy being allowed in
those days. J acob ended up with two wives, twelve sons, who
became the patriarchs of the twelve tribes of Israel, and a lot of
domestic friction which is not surprising Some argue that
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3
domestic friction, which is not surprising. Some argue that
J acob really had forward contracts, which obligated him to the
marriages but that does not matter. J acob did derivatives, one
way or the other.
4
5 SLIDES
Approx 1637
The first exchange for trading derivatives appeared to be the
Royal Exchange in London, which permitted forward Royal Exchange in London, which permitted forward
contracting. The Dutch Tulip bulb mania, (see Extraordinary
Popular Delusions and the Madness of Crowds by Charles
Mackay (1841)) but was characterized by forward contracting
on tulip bulbs around 1637.
Approx 1650
The first "futures" contracts are generally traced to the Yodoya
rice market in Osaka J apan around 1650 These were evidently
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4
rice market in Osaka, J apan around 1650. These were evidently
standardized contracts, which made them much like today's
futures, although it is not known if the contracts were marked
to market daily and/or had credit guarantees.
5 SLIDES
1973
1973 marked the creation of both the Chicago Board Options
Exchange and the publication of perhaps the most famous
formula in finance the option pricing model of Fischer Black formula in finance, the option pricing model of Fischer Black
and Myron Scholes. These events revolutionised the investment
world in ways no one could imagine at that time. The Black-
Scholes model, as it came to be known, set up a mathematical
framework that formed the basis for an explosive revolution in
the use of derivatives.
1994
In 1994 the derivatives world was hit with a series of large
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In 1994 the derivatives world was hit with a series of large
losses on derivatives trading announced by some well-known
and highly experienced firms, such as Procter and Gamble and
Metallgesellschaft. One of Americas wealthiest localities,
Orange County, California, declared bankruptcy, allegedly due
to derivatives trading
5
5 SLIDES
1995
Barings Bank declared bankruptcy due to unauthorised
speculative trading in futures and options contracts Nick speculative trading in futures and options contracts Nick
Leeson.
1997
Nobel Prize in Economics awarded to Robert Merton and Myron
Scholes.
1999
A g o p of de i ati es t ade s at CSFB nicknamed The Flaming
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A group of derivatives traders at CSFB nicknamed The Flaming
Ferraris are sacked following allegations of illegal trades in an
attempt to manipulate the Swedish stock market index.
5 SLIDES
2001
Enron, the 7th largest company in the US and the world's
largest energy trader made extensive use of energy and credit largest energy trader made extensive use of energy and credit
derivatives but becomes the biggest firm to go bankrupt in
American history after systematically attempting to conceal
huge losses
2002
Warren Buffet calls credit derivatives financial weapons of
mass destruction in his annual letter to investors
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2007-2009
Credit Derivatives are blamed for the global financial crisis
6
WHY ARE DERIVATIVES SO POPULAR?
Oil prices: 1951-1999 DM/$ rate: 1951-1999 p /$
Fig. 1.1
Fig. 1.2
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HOW BIG IS THE MARKET?
700,000
Notional Amount Outstanding of over-the-counter (OTC) Derivatives
According to The B.I.S. Semi-Annual Survey ($Bn)
200 000
300,000
400,000
500,000
600,000
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0
100,000
200,000
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2008 2009 2010
7
DERIVATIVES MARKETS
Over-the-counter (OTC)
A computer- and telephone-linked network of dealers
at financial institutions, corporations, and fund at financial institutions, corporations, and fund
managers
Contracts can be non-standard and there is some
small amount of credit risk
Exchange traded
Traditionally exchanges have used the open outcry
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Traditionally exchanges have used the open-outcry
system, but majority of trading is done electronically
Contracts are standardized
There is virtually no credit risk
WAYS DERIVATIVES ARE USED
To hedge risks
Commodity producers and international trade
l ( k h f To speculate (take a view on the future
direction of the market)
To gain leverage or utilize information more
precisely. For example, how one can make money in
a stable market?
To lock in an arbitrage profit
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To lock in an arbitrage profit
E.g. Arbitrage between index components and index
futures
8
WAYS DERIVATIVES ARE USED
To change the nature of a liability
Interest rate swap to reduce mortgage risk in banks
To change the nature of an investment without
incurring the costs of selling one portfolio and
buying another
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To bypass regulations and laws
Forward contract
DISCOUNTING & COMPOUNDING
(A REVISION)
Hopefully we all agree that a dollar today is
worth more than a dollar tommorow
(IF NOT PLEASE LEAVE NOW!) (IF NOT PLEASE LEAVE NOW!)
Discounting is how we formalise the relationship
between the value of cashflows occuring on
different dates
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For example if the 1 year interest rate is 4%,
how much is $100 to be received in 1 years
time worth today?
9
(A REVISION)
COMPOUNDING
A principal amount, P, invested at an annual
i t t t d d ll f T interest rate, r, compounded annually, for T
years would grow to:
A
T
= P(1 + r)
T
If compounded Quarterly:
A
T
= P(1 +r/4)
4T
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A
T
= P(1 +r/4)
If compounded Daily:
A
T
= P(1 +r/365)
365T
(A REVISION)
COMPOUNDING
The general result for interest rate, r, with m
di i d i compounding periods per year is
A
T
= P(1 +R/m)
mT
What happens when mgoes to infinity?
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What happens when m goes to infinity?
10
(A REVISION)
CONTINUOUS COMPOUNDING
As m increases the length of every compounding
i d di i i h til h ti period diminishes until we reach continuous
compounding
|
.
|
\
|
+ =

mT
m
T
m
r
1 P Limit A
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rT
T
Pe A =
(A REVISION)
DI SCOUNTI NG
Cashflow, CF, to be received in T years when the annual
i t t t i i th t d interest rate is r, is worth today:
If the rate is continuously compounded
T
T
0
r) (1
CF
PV
+
=
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rT -
T 0
e CF PV =
11
(A REVISION)
DI SCOUNTI NG
More formally, the DISCOUNT FACTOR, for a date T is
th t l f 1 t th d t T the present value of 1 at the date T
Given a set of discount factors a series of cashflows can
be discounted
rT -
T
e DF =
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be discounted
T 0
DF PV =
T
CF
(A REVISION)
DI SCOUNTI NG
In reality continuously compounded zero coupon rates
f i d t i th f t t dil il bl i for various dates in the future are not readily available in
the market place. This is because Zero-coupons are rare,
illiquid and not customisable
Structurers use structured swaps, exchanging a floating
rate paid by the issuer against a fixed rate, in order to
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create a synthetic zero-coupon. These are calculated
using a procedure called bootstrapping
12
FORWARD CONTRACTS
A forward contract is an agreement to buy or sell
t t t i ti i th f t f t i an asset at a certain time in the future for a certain
price (the delivery price)
It can be contrasted with a spot contract which is
an agreement to buy or sell immediately
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20
It is traded in the OTC market
FORWARD CONTRACTS
Long Position
Used to protect (lock in) the purchase price of an asset one is
planning to buy
OR OR
Used to speculate on a rise in the price of the asset
Short Position
Used to protect the selling price of an asset one is planning to
sell
OR
Used to speculate on a fall in the price of the asset
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Payoff
The payoff will depend upon the spot price at the delivery date.
Payoff = Spot Price Delivery Price
13
FORWARD CONTRACTS
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CONSUMPTI ON VS I NVESTMENT ASSETS
Investment assets are assets held by significant
b f l l f i t t numbers of people purely for investment
purposes (Examples: gold, silver, equities)
Consumption assets are assets held primarily
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23
for consumption (Examples: copper, oil)
14
GOLD: AN ARBITRAGE OPPORTUNITY?
Nick Motson
24
From Bloomberg:
The spot price of gold is US$1 710 00 The spot price of gold is US$1,710.00
The quoted 2-year forward price of gold is
US$1,733.50
The 2-year (continuously compounded) US$ interest
rate is 0.65% per annum
No income or storage costs for gold (an assumption)
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25
Is there an arbitrage opportunity?
15
If the spot price of gold is S& the futures or
forward price for a contract deliverable in T
years is F, then years is F, then
F = S e
rT
where r is the continuously compounded rate of
interest.
In our example, S=$1,710.00, T=2, and
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In our example, S $1,710.00, T 2, and
r= 0.65% so that
F =$1,710.00e
(0.0065 * 2)
=$1,732.38
Theoretical Forward Price =$1,732.38
Actual Forward Price = $1,733.50
How do you arbitrage this?
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27
16
At Time 0 At Time 2
Borrow $1,710.00
(will need to repay
$1,732.38)
Buy Gold for $1,710.00
Sell Gold 2 years Forward
Deliver Gold
Receive $1,733.50
Payoff loan with $1,732.38
Profit = $1,733.50
-$1,732.38
$0 92
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28
@ $1,733.50
$0.92
A Lot of work for a 0.92/ 1710 = 0.05% profit !!!
ARBITRAGE GENERALIZATION
S
0
-> Asset Price T -> Time to Maturity
r -> Riskless IR F
0
-> Forward Price
rT
e S F
0 0
=
If F
0
> S
0
e
rt
then
the arbitrageurs
If F
0
< S
0
e
rt
then
the arbitrageurs
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29
g
can buy the asset
and short the
forward contract
the arbitrageurs
can short the asset
and enter into a
long forward
contract
17
S&P500: AN ARBITRAGE OPPORTUNITY?
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30
From Bloomberg:
The spot price of the S&P 500 is 1 257 The spot price of the S&P 500 is 1,257
The quoted 1-year forward price is 1,234
The 1-year (continuously compounded) US$ interest
rate is 0.87% per annum
Is there an arbitrage opportunity?
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31
g pp y
18
When an Investment Asset Provides a Known
Yield
F
0
= S
0
e
(rq )T
where qis the average yield during the life of
th t t ( d ith ti
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32
the contract (expressed with continuous
compounding) In our case that is the dividend
yield.
FORWARD PRICES OF STORABLE
COMMODITIES
Commodity forward contracts have two important
features that are not present when the underlying is a
financial asset.
Storage Costs
Convenience Yields
Storage Costs
Warehouse space, transportation costs, spoilage,
insurance. We will represent these charges as a fraction
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33
p g
of the market price of the commodity. If storage costs
are 5%, this implies that the annualized storage costs
are about 5% of the spot market price.
19
COMMODITIES
The Convenience Yield
Unlike securities, commodities are usually consumed or used in
a production process.
Having a commodity on hand has value since it allows the
production process to continue without disruptions.
If the commodity is abundant then there is not much benefit
from having it in storage. However, if the commodity is scarce,
then having the commodity in inventory is very beneficial.
One can view the potential benefit of having a commodity on
hand as a yield, just like a continuous dividend yield. We
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34
y , j y
express the convenience yield as a percent of the price in an
annualized form. The convenience yield will be greater if there
is a greater chance of a shortage of the asset.
COMMODITIES
How Do Storage Costs & Convenience
Yields Effect The Shape Of The Forward
Curve? Curve?
As we have already seen, interest costs lead to an
upward sloping forward curve
We have also see that a positive yield from the asset
will reduce this upward slope (possible even make it
negative if q>r)
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35
20
COMMODITIES
Contango - future prices are higher than current spot
price
B k d ti f t i l th t
Ti
Forward price in BACKWARDATION: F < S
F
o
r
w
a
r
d

Backwardation future prices are lower than current
spot price
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36
Time
Forward price in CONTANGO: F > S
P
r
i
c
e
A GENERALISATION OF THE ARBITRAGE
CONDI TI ONS
The cost of carry, c, is the storage cost plus the
interest costs less the income earned
For an investment asset F
0
= S
0
e
cT
For a consumption asset F
0
s S
0
e
cT
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37
The convenience yield on the consumption
asset, y, is defined so that F
0
=S
0
e
(cy )T
21
OIL FORWARDS IN CONTANGO
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OIL FORWARDS IN BACKWARDATION
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22
NATURAL GAS FORWARDS
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40
A foreign currency is analogous to a security providing
a dividend yield
FORWARDS ON CURRENCIES
The continuous dividend yield is the foreign risk-free
interest rate
It follows that if r
f
is the foreign risk-free interest rate
F S e
r r T
f
0 0
=
( )
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41
F S e
0 0
23
The USD/J PY Carry Trade
FORWARDS ON CURRENCIES
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42
FORWARD CONTRACT RISKS
Assuming an agreement is reached by the two
participants, the greatest risk is that the other
party might default on their obligation party might default on their obligation.
This is especially true since one side will profit
and the other side will loose.
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43
Futures contracts traded on an exchange will
attempt to eliminate the risk of default.
24
OTHER FORWARD CONTRACT RISKS
One goal of the negotiation is to specify exactly
the type, quantity, and means of delivery of the
underlying asset. underlying asset.
The chance that an asset different than
anticipated might be delivered should be
eliminated by the contract. This can be an
advantage of forward contracts.
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44
Futures contracts attempt to account for this
problem via standardization of the contract.
FUTURES VS FORWARDS
While forward contracts provide the ability to
negotiate very specific agreements they also
l i k i ll li idit d d f lt carry large risks, especially liquidity and default
risk.
Futures contracts are designed to be more
general and have broad appeal to a larger
k
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45
market.
25
FUTURES CONTRACTS
Futures are standardized forward contracts
Parties are matched by a clearinghouse
Specify underlying asset and amount
Type of settlement
Currency used
Grade of deliverable
D li d t i
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46
Delivery date or expiry
FUTURES CONTRACTS
Futures are margined
Traders must post an initial margin, 5-15%
M i d th ft t t i d il Margined thereafter to spot price daily
Prevents large balances between parties
Kept in margin accounts
Reduces credit risk!
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47
26
FUTURES CONTRACTS
Settlement
Physical delivery
C h ttl t Cash settlement
Expiry
Arbitrage opportunity in last moments
Underlying spot price vs. futures price
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FUTURES CONTRACTS
Types of traders
H d Hedgers
Have an interest in owning the underlying, want to limit
their exposure to risk
Speculators
Have no interest in underlying, willing to take on risk for
opportunity to profit
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49
27
FUTURES CONTRACTS
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50
FUTURES CONTRACTS
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51
28
Specifications of
Futures Contract
The Asset
The Contract Size
Delivery Arrangements
Delivery Months
Price Quotes
Price Limits
Position Limits
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52
Position Limits
CONTRACT SPECI FI CATI ONS: THE ASSET
The can be a wide variation in the quality of a
given asset, therefore the contract typically is
very specific concerning the assets that are very specific concerning the assets that are
acceptable for delivery.
Often there are substitutable assets which can
be delivered if the short position pays a penalty
for delivering an asset of different quality than
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53
for delivering an asset of different quality than
specified in the contract.
29
CONTRACT SPECI FI CATI ONS:
CONTRACT SI ZE
Contract Size
The amount of asset that is to be delivered for one
contract contract
The size of a contract is targeted toward the market
that is most likely to be trading the underlying asset.
Often financial contracts have a larger $ value than
commodities.
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54
CONTRACT SPECIFICATIONS
Delivery Arrangements Delivery Arrangements
More important for commodities than financial assets.
Specify how delivery occurs and location.
Again substitutions may be made at a premium
Arrangement specified include location and date
of delivery.
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55
30
FUTURES CONTRACTS
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FUTURES CONTRACTS
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57
31
OPEN INTEREST
Open Interest
The number of contracts that are currently open
(both a short and long position exist). (both a short and long position exist).
What happens to open interest if a new long position
is taken out?
It could increase
It could decrease
It might not change.
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58
The answer depends on whether both the long and short
positions are new, or closing out or one of each.
MARGIN REQUIREMENTS
To limit counter party default risk, the futures exchange
requires participants to place funds in a margin account
when the contract is taken out.
Some Terminology:
Initial Margin: The original amount deposited in the margin
account
Maintenance margin: The amount that must remain in the
margin account
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59
Margin call Notice that the margin account has dropped below
the maintenance margin, more money must be added to the
account
32
MARGIN EXAMPLE
Example:
An investor has taken a long position in gold (agreed
to buy gold at some date in the future) to buy gold at some date in the future).
Assume that the agreement is for 2 gold contracts
each contract consists of 100 ounces of gold. The
futures price is $1000 per ounce.
This implies that the participant would need
200*1000 = $200,000 to purchase gold at the
i ti f th t t
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60
expiration of the contract.
MARGIN EXAMPLE
If the futures price for gold decreases to $995,
the investor would suffer a loss if the contract is
closed out closed out.
The loss would total (1000 - 995)200 = $1000.
The fear is that if at the expiration of the contract
the price is $995 the participant will not honor the
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the price is $995, the participant will not honor the
contract since it would result in a loss of $1000.
33
MARGIN EXAMPLE
To counteract this the investor is ask to put a
sum of money into a margin account lets
assume $2 000 per contract or $4000 total assume $2,000 per contract or $4000 total.
When the futures price declines the loss of
$1000 is taken from the margin account of the
investor and given to a participant that took a
short position
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62
short position.
MARGIN EXAMPLE
The value of the contract is marked to market
each day, and the margin account is adjusted.
The margin is effectively guaranteeing that the The margin is effectively guaranteeing that the
position is covered.
If the level of the account falls below the
maintenance margin the investor is required to
put more funds into the account this is known
i ll Th t f d id d
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63
as a margin call. The extra funds provided are
the variation margin, if they are not provided
the broker will close out the account.
34
ROLE OF CLEARINGHOUSE
The clearinghouse serves as an intermediary
that guarantees the contract.
The clearinghouse is an independent
corporation whose shareholders are comprised
of its member firms. Each member firm
maintains a margin account (similar to the
traders) with the clearinghouse.
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64
In essence the clearinghouse guarantees the
long and the short trader that the other side will
honor the contract
ARE FORWARD & FUTURE PRICES EQUAL?
In theory they are, when risk- free interest rate
is constant and the same for all maturities
Wh IR di t bl th i b i t When IRs vary unpredictably the prices begin to
differ
think of the situation where the price of S is
positively correlated to interest rates (future prices
tend to be higher)
Taxes
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65
Transaction costs
Treatment of margins
Future contracts are more liquid and easier to trade
35
FORWARDS VS FUTURES CONTRACTS
Forward Contracts Futures Contracts
Private contract between Traded on
two parties an exchange two parties an exchange
Not Standardized Standardized
Usually a single delivery date Range of delivery dates
Settled at the end of contract Settled daily
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Settled at the end of contract Settled daily
Delivery or final cash Contract is usually closed
settlement usually takes place out prior to maturity
READING THIS WEEK
Compulsory
The Metallgesellschaft case study
Kuprianov (1995) - Derivatives Debacles,Richmond Fed Kuprianov (1995) Derivatives Debacles,Richmond Fed
http://www.richmondfed.org/publications/research/economic_quarterly/1995/fall/kuprianov.cfm
Read up to Page 20 and be ready to discuss in class next
week
Optional
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67
Hull, Options, Futures & Other Derivatives,
Chapter 4 Interest Rates
Chapter 5 - Determination of Forward and Futures Prices
36
Lecture2 - Options Lecture 2 Options
) ( ) (
2 1 0
d N e X d N S c
rT

T r X S
d

0
) 2 /
2
( ) / ln(
h
"I don't buy options 90 percent of all long options lose money "
T d
T
T r X S
d
T
d
1
0
2
0
1
) 2 /
2
( ) / ln(

) ( ) (
where
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1
I dont buy options....90 percent of all long options lose money.
J im Rogers.
37
INTRODUCTION
Last week we covered forwards & futures
These are what are termed non-conditional
derivatives derivatives
By entering into a forward contract you undertake an
OBLIGATION to buy or sell an asset at a fixed price
These week we will cover options
These are conditional derivatives
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Buying options gives you the RIGHT but not the
OBLIGATION to buy or sell an asset at a fixed price
OPTIONS TERMINOLOGY
Price at which you buy or sell
STRIKE
Price at which you buy or sell
STRIKE
Option to Buy CALL
Option to Sell PUT
P i id f th O ti PREMIUM
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Price paid for the Option PREMIUM
38
OPTIONS TERMINOLOGY
The strike price is
favourable compared to
IN THE MONEY
favourable compared to
current market price
IN THE MONEY
The strike price is not
favourable compared
to current market
price
OUT OF THE
MONEY
Nick Motson
4
p
The strike price is equal
to current market price
AT THE MONEY
OPTIONS TERMINOLOGY
Option can only be Option can only be
exercised at the specified
maturity date
EUROPEAN STYLE
Option can be
exercised at any point
AMERICAN STYLE
Nick Motson
5
y p
up to the specified
maturity date
AMERICAN STYLE
39
OPTIONS TERMINOLOGY
One can be BUYER or SELLER of the two types of
options so we have 4 basic strategies:
BUYER of the right to BUY LONG CALL
SELLER of the right to BUY SHORT CALL
BUYER of the right to SELL LONG PUT
Nick Motson
6
SELLER of the right to BUY SHORT CALL
SELLER of the right to SELL SHORT PUT
OPTION PAYOFFS
Spot Price = S
Strike Price =X
{ } X S MAX y latMaturir ValueOfCal = , 0
{ } S X MAX AtMaturity ValueOfPut = , 0
Nick Motson
7
40
Example: Buy a call option
Strike = 100, Maturity = 1 Year, Premium = 5
P&L
CALL OPTION PAYOFF
100
Premium -5
200
P&L
STOCK PRICE
+95
Nick Motson
8
100
Premium -5
200
STOCK PRICE
OUT OF THE MONEY IN THE MONEY
AT THE MONEY
Example: Buy a put option
Strike = 100, Maturity = 1 Year, Premium = 5
P&L
PUT OPTION PAYOFF
100
Premium -5
50
P&L
STOCK PRICE
+45
Nick Motson
9
100
Premium -5
50
STOCK PRICE
IN THE MONEY OUT OF THE MONEY
AT THE MONEY
41
OPTION PAYOFFS
The buyer of the option has a RIGHT but no
OBLIGATION to act. He will use his right
(exercise) only if it is in his own interest (exercise) only if it is in his own interest.
The seller of the option has an OBLIGATION
which will only take place if it is against his
interest
Nick Motson
10
So selling options can be very risky
(just ask Nick Leeson)
THE 4 BASIC OPTION PAYOFF DIAGRAMS
LONG CALL LONG PUT
SHORT CALL SHORT PUT
Nick Motson
11
42
OPTION VALUATION
USING
BINOMIAL TREES
Nick Motson
12
BINOMIAL VALUATION OF A CALL OPTION
Stock price is currently 100
In three months it will be either 110 or 90
Assume the risk free rate is 5%
Stock Price = 110
Stock price = 100
Nick Motson
13
Stock Price = 90
43
Consider a 3-month call option on the stock that
has a strike price of 105.
{ } X S MAX l M i V l OfC l 0
Stock Price = 110
Option Value = 5
St k P i 90
Stock price = 100
{ } X S MAX y latMaturir ValueOfCal = , 0
Nick Motson
14
Can we calculate the value of the call today?
Stock Price = 90
Option Value = 0
Create a riskless portfolio:
- Short 1 call option
- Long Shares Long Shares
Stock Price = 110
Portfolio Value = 110 - 5
Stock Price = 90
Portfolio Value = 90
Stock price = 100
Nick Motson
15
This portfolio is riskless if 110A 5 = 90A
Therefore =0.25
o t o o a ue 90
44
We now know that the value of the portfolio in
3 months time is either
110A 5 = (110 x 0.25) 5 = 22.50
OR
90A = 90 x 0.25 = 22.50
Hence the value of the portfolio today must be
Nick Motson
16
Hence the value of the portfolio today must be
just the discounted value of 22.50
Value Today = 22.50e
-rt
= 22.50e
-(0.05 x 0.25)
= 22.22
Recall that the portfolio is long Shares and short
1 call option.
Knowing that the value of the portfolio today is
22.22 we can now decompose it into its 2 parts
Value of Portfolio = Value of Shares - Value of Short Option
(22 22) (0 25 x 100) (?)
Nick Motson
17
(22.22) (0.25 x 100) (?)
Value of Option = 25.00 22.22 = 2.78
45
BINOMIAL VALUATION OF A PUT OPTION
Under the same assumptions can we value a put option
with the same strike of 105?
{ } S X MAX AtMaturity ValueOfPut = 0
Stock Price = 110
Option Value = 0
St k P i 90
Stock price = 100
{ } S X MAX AtMaturity ValueOfPut = , 0
Nick Motson
18
Stock Price = 90
Option Value = 15
Create a riskless portfolio:
- Short 1 put option
- Long Shares Long Shares
Stock Price = 110
Portfolio Value = 110
Stock Price = 90
Portfolio Value = 90 - 15
Stock price = 100
Nick Motson
19
This portfolio is riskless if 110A = 90A -15
Therefore =-0.75 (actually need to be short shares!)
o t o o a ue 90 5
46
We now know that the value of the portfolio in 3
months time is
90A 15 110A (110 0 75) 82 50 90A 15 = 110A = (110 x -0.75) = -82.50
Hence the value of the portfolio today is
Value Today = -82.5e
-(0.05 x 0.25)
= -81.48
So to calculate the value of our put option
Nick Motson
20
Value of Short Option = Value of Shares Value of Portfolio
Value of Option = (100 x -0.75)-(-81.48) =6.48
GENERALIZATION OF BINOMIAL PRICING
A derivative f with maturity T years depends
of the price of an asset S.
Th k t i th t i d h 2 t t The market in the next period has 2 states u
(up) and d (down) which are denoted by a
percentage change a
S(1+a)=S
u
u
S
Nick Motson
21
S(1-a)=S
d
d
S
47
Create a portfolio that is long of the asset and
short 1 derivative
S A
The portfolio is riskless when
S
u
A
u
= S
d
A
d
S
u
A
u
S
d
A
d
S

Nick Motson
22
S
u
A
u
S
d
A
d
hence
d u
d u
S S
f
= A
Value of the portfolio at time T is
S
u
A
u
Value of the portfolio today is Value of the portfolio today is
(S
u
A
u
)e
rT
Another expression for the portfolio value today
is
SA f
Nick Motson
23
Hence
=S A (S
u
A
u
)e
rT
48
GENERALISATION BINOMIAL VALUATION
So far we have valued our option without any
reference to the probabilities of moving up or
down down
If the probability of an up-move is p, then
wouldnt life be simpler?

Nick Motson
24
f = ((p
u
+(1-p)
d
)e
-rT
d
If you think back to last week, what is the
expected value of S at time T?
If p is the risk neutral probability
S
u
S
d
S E(S) =Se
rt
Nick Motson
25
If p is the risk-neutral probability,
pS
u
+(1-p)S
d
=Se
rT
49
With a little bit of algebra we can re-arrange
rt
d u
Se S p pS = + ) 1 (
to solve for p
and if we define u as an up-move & d as a down-
d u
p p ) (
d u
d
rt
S S
S Se
p
=
Nick Motson
26
p
move whereby S
u
= S x u and S
d
= S x d
d u
d e
p
rt
=
So revisiting our earlier examples:
Stock Price = 110
Therefore
u=110/100 = 1.1
d = 90/100 = 0 9
Stock Price = 90
Stock price = 100
Nick Motson
27
d = 90/100 = 0.9
Hence
P = e
(0.05 x 0.25)
0.9 / 1.1 - 0.9 = 0.5629
50
To value the 105 CALL:
f = ((p
u
+(1-p)
d
)e
-rT
P=0.5629,
u
=5,
d
=0, r=5% and t=0.25
f= 2.78 (phew, same as on slide 17!)
To value the 105 PUT:
f (( +(1 ) )
rT
Nick Motson
28
f = ((p
u
+(1-p)
d
)e
-rT
P=0.5629,
u
=0,
d
=15, r=5% and t=0.25
f= 6.48 (phew, same as on slide 20!)
A MULTIPLE PERIOD EXAMPLE
Using the same U and D (hence P= 0.5629),
over 2 periods, S will do the following
121
100
110
121
99
Nick Motson
29
could we value an option?
90
81
51
Simply start at the end and work backwards,
using the 105 call example the option payoffs
are given in brackets are given in brackets
100
110
121
99
[16]
[0]
B
C
A
D
E
Nick Motson
30
90
81
[0]
C
F
At Node B
value = e
(-0.05 x 0.25)
x [(0.5629 x 16) +(0.4371 x 0)]
8 8944 =8.8944
At Node C
value = 0
At Node A
value = e
(-0.05 x 0.25)
x [(0.5629 x 8.8944) +(0.4371 x 0)]
Nick Motson
31
[( ) ( )]
= 4.944
52
WHY USE BINOMIAL TREES?
There is no limit to how many branches the tree
can have, so you can see the evolution of the
asset price and the option payoff at each step asset price and the option payoff at each step.
This is especially useful in the cases of:
American style options (might exercise early)
Path dependent options (we will look at barrier
options next week)
Nick Motson
32
options next week)
Asian options (again next week)
Other exotics
BINOMIAL TREES THE QUESTION I
HAVENT ANSWERED YET
Where do we get the values of u and d?
- Did I just pluck them from the air? (yes I did
actually)
- Cox, Ross, and Rubinstein suggest you use the
following:
t
t
e d
e u
A
A
=
=
o
o
Nick Motson
33
where o is annualized the volatility and t is the length
of the time step (more on volatility later)
e d =
53
OPTION VALUATION
USING
THE BLACK-SCHOLES MODEL
Nick Motson
34
THE RANDOM WALK ASSUMPTION
Consider a stock whose price is S
In a short period of time of length ot the change in In a short period of time of length ot the change in
the stock price is assumed to be normal with mean
Sot and standard deviation .
Where is expected return and o is volatility
t S o o
Nick Motson
35
These assumptions imply ln S
T
is normally distributed
with mean and standard deviation
T.
T S ) 2 / ( ln
2
0
o +
54
LOG NORMALITY
Nick Motson
36
) 1 ( ) ( var
) (
2
2 2
0
0
=
=
T T
T
T
T
e e S S
e S S E
o
THE EXPECTED RETURN

The expected value of the stock price is S
0
e
T
The expected return on the stock with continuous
compounding is o
2
/2
The arithmetic mean of the returns over short
periods of length ot is
Nick Motson
37
The geometric mean of these returns is o
2
/2
55
THE VOLATILITY
The volatility is the standard deviation of the
continuously compounded rate of return in 1 year
The standard deviation of the return in time ot is
t
Nick Motson
38
WHY WERE BLACK AND SCHOLES SO
SMART?
The option price and the stock price depend on
the same underlying source of uncertainty
We can form a portfolio consisting of the stock
and the option which eliminates this source of
uncertainty
The portfolio is instantaneously riskless and
must instantaneously earn the risk-free rate
Nick Motson
39
must instantaneously earn the risk-free rate
NO NEED TO KNOW !!!!!!!
56
THE BLACK AND SCHOLES FORMULAE
d N S d N X
d N e X d N S c
rT
rT
=
2 1 0
) ( ) (
) ( ) (
T d
T r X S
d
T
T r X S
d
d N S d N e X p
rT
o
o
o
+
+ +
=
=
0
0
1
1 0 2
) 2 /
2
( ) / ln(
) 2 /
2
( ) / ln(
where
) ( ) (
Nick Motson
T d
T
d o
o
= =
1
0
2
) ( ) (

The N(x) Function
N(x) is the probability that a normally
di t ib t d i bl ith f d distributed variable with a mean of zero and a
standard deviation of 1 is less than x
In the olden days we got this from tables but
now it is easily calculated in excel using the
d () f
Nick Motson
41
Normsdist() function.
57
FACTORS INFLUENCING THE OPTION
PREMIUM
An increase in the price of
underlying increases the cost of
call & cheapens puts
PRICE OF
UNDERLYING (S
0
)
Increasing the strike price lowers the
price of calls & increases the price of
puts
STRIKE (X)
Longer options are more expensive
MATURITY (T)
Higher rates increases the price of
calls and lowers the price of puts
INTEREST RATES (r)
Nick Motson
42
Higher volatility makes options more
expensive
VOLATILITY ()
calls and lowers the price of puts
WHY WERE BLACK AND SCHOLES NOT SO
SMART?
All of the inputs for the formulae are observable
EXCEPT volatility
The correct volatility to use is the volatility over
the life of the option (this is in the future so
quite hard to observe)
Nick Motson
43
58
HISTORICAL VOLATILITY
This is really easy to calculate:
1 Take observations S S S at intervals of years (usually 1. Take observations S
0
, S
1
, . . . , S
n
at intervals of t years (usually
daily)
2. Define the continuously compounded return as:
3. Calculate the standard deviation, s , of the u
i
s
|
|
.
|
\
|
=
1
ln
t
t
i
S
S
u
Nick Motson
44
, ,
i
4. The historical volatility estimate is:
t
= o
s
IMPLIED VOLATILITY
The implied volatility of an option is the volatility for
which the Black-Scholes price equals the market price which the Black Scholes price equals the market price
The is a one-to-one correspondence between prices
and implied volatilities
Traders and brokers often quote implied volatilities
Nick Motson
45
rather than dollar prices
59
OPTIONS THE GREEKS
Change in price of option for
change in price of underlying
DELTA
Change in Delta for change in GAMMA
1% change in volatility
VEGA
Change in Delta for change in
price of underlying
GAMMA
Theta is the rate of change of the
options value as time (1 day)
THETA
Nick Motson
46
passes
Rho is change in the price of the
option for a 1% change in interest
rates
RHO
OPTIONS THE GREEKS
We will cover the greeks in more depth next
week before we look at exotic options, but to
summarise
Long
Call
Short
Call
Long
Put
Short
Put
Delta + - - +
Gamma + - + -
V
summarise
Nick Motson
47
Vega + - + -
Theta - + - +
Rho + - - +
60
OPTION STRATEGIES
(AFTER ALL THIS ISNT AN ALGEBRA COURSE)
Nick Motson
48
BASIC OPTION PAYOFF DIAGRAMS
LONG CALL LONG PUT
SHORT CALL SHORT PUT
Nick Motson
49
61
OPTION STRATEGIES
We can combine the various options to give
various payoff. Remember whenever you buy
and sell options you are not only taking and sell options you are not only taking
exposure to the underlying asset but also to
volatility & interest rates.
The most significant of these is volatility
Nick Motson
50
OPTION STRATEGIES
Asset
Neutral Bullish Bearish
V
o
l
a
t
i
l
i
t
N
e
u
t
r
a
l
Do Nothing Buy Call Spread
Sell Risk Reversal
Buy Put Spread
Buy Risk Reversal
B
u
l
l
i
s
h
Buy Straddle
Buy Strangle
Sell Butterfly
Buy Call Buy Put
Nick Motson
51
t
y
B
e
a
r
i
s
h
Sell Straddle
Sell Strangle
Buy Butterfly
Sell Put
Buy Call Ladder
Buy Ratio Call
Spread
Sell Call
Buy Put Ladder
Buy Ratio Put Spread
62
OPTION STRATEGY PAYOFF DIAGRAMS
LONG CALL SPREAD
Nick Motson
52
LONG 1 CALL + SHORT 1 CALL WITH HIGHER STRIKE
LONG PUT SPREAD
Nick Motson
53
LONG 1 PUT + SHORT 1 PUT WITH LOWER STRIKE
63
LONG STRADDLE
Nick Motson
54
LONG 1 PUT + LONG 1 CALL WITH SAME STRIKE
SHORT STRADDLE
Nick Motson
55
SHORT 1 PUT + SHORT 1 CALL WITH SAME STRIKE
64
LONG STRANGLE
Nick Motson
56
LONG 1 PUT (LOWER STRIKE) + LONG 1 CALL (HIGHER STRIKE)
LONG BUTTERFLY
Nick Motson
57
SHORT 1 PUT + SHORT 1 CALL (SAME STRIKE)+
LONG 1 CALL (HIGHER STRIKE) + LONG 1 PUT (LOWER STRIKE)
OR IT CAN BE CONSTRUCTED ENTIRELY FROM CALLS OR PUTS
65
LONG RATIO CALL SPREAD (1 BY 2)
Nick Motson
58
LONG 1 CALL + SHORT 2 CALLS WITH HIGHER STRIKE
LONG CALL LADDER
Nick Motson
59
LONG 1 CALL + SHORT 1 CALL WITH HIGHER STRIKE +
SHORT 1 CALL WITH AN EVEN HIGHER STRIKE
66
LONG COMBO (RISK REVERSAL)
Nick Motson
60
SHORT 1 CALL + LONG 1 PUT WITH LOWER STRIKE
READING THIS WEEK
Compulsory
The WSJ article (2 pages) - be ready to discuss in class next week
Play with the option strategy spreadsheet (its on Moodle) Play with the option strategy spreadsheet (it s on Moodle)
Options-based Investment Strategies: The Case of the CBOE S&P
500 BuyWrite Index (abstract + conclusion & skim the rest)
Optional
Nick Motson
61
Chapter 8 - Mechanics of Options Markets.
Chapter 9 - Properties of Stock Options.
Chapter 10 - Trading Strategies Involving Options.
Chapter 11 - Binomial Trees.
67
Lecture3 Advanced& Lecture 3 Advanced &
Exotic Options
Nick Motson
1
"I Never invest in any idea you can't illustrate with a crayon."
Peter Lynch.
68
INTRODUCTION
Last week we covered the basics of options
By now you should be familiar with the basic payoff
diagrams & how to combine them to produce various diagrams & how to combine them to produce various
strategies
These week we will cover options in more depth
& introduce exotic options
Nick Motson
2
AA
GREEK
MASTER CLASS
Nick Motson
3
69
A REMINDER OF THE GREEKS
change in price of underlying
DELTA
Change in Delta for change in GAMMA
1% change in volatility
VEGA
Change in Delta for change in
price of underlying
GAMMA
Theta is the rate of change of the
options value as time (1 day)
THETA
Nick Motson
4
passes
Rho is change in the price of the
option for a 1% change in interest
rates
RHO
VALUE OF A CALL OPTION OVER TIME
Value Of a 100 Strike Call
50.0
60.0
10.0
20.0
30.0
40.0
V
a
l
u
e
Nick Motson
5
-10.0
0.0
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
1 Year to Expiry 6 Month to Expiry 1 Month to Expiry At Expiry
70
VALUE OF A PUT OPTION OVER TIME
Value Of a 100 Strike Put
50.0
60.0
10.0
20.0
30.0
40.0
V
a
l
u
e
Nick Motson
6
-10.0
0.0
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
1 Year to Expiry 6 Month to Expiry 1 Month to Expiry At Expiry
DELTA
Defined as the rate of change of an option price with
respect to the price of the underlying asset. It is the
slope of the curve that relates the option price to the p p p
underlying asset price.
i.e. how much do you make or lose on the option as
the underlying asset moves.
) ( = = A d N
c o
Nick Motson
7
1 ) (
) (
1
1
= = A
= = A
d N
S
p
d N
S
put
call
o
o
o
71
DELTA
From these formulae it should be clear that the delta
of a call is always between 0 and 1 while the delta
of a put is between 0 and -1. p
A portfolio that consists of an option and a position
in the underlying asset equal to the inverse of the
delta will be delta neutral or delta hedged.
i t h d l ll iti h t th
Nick Motson
8
i.e. to hedge a long call position you go short the
asset while to hedge a long put position you go long
the asset.
Delta of 100 Strike Call vs Price Of Underlying Asset Over Time
0 8
0.9
1.0
DELTA
0.2
0.3
0.4
0.5
0.6
0.7
0.8
D
e
l
t
a
Nick Motson
9
0.0
0.1
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
Delta 1 Year to Expiry Delta 6 Months to Expiry Delta 1 Month to Expiry
72
DELTA
Delta of 100 Strike Put vs Price Of Underlying Asset Over Time
0 2
-0.1
0.0
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
0 8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
D
e
l
t
a
Nick Motson
10
-1.0
-0.9
-0.8
Asset Price
Delta 1 Year to Expiry Delta 6 Months to Expiry Delta 1 Month to Expiry
DELTA
Delta Hedge Example
Assumptions: Assumptions:
S
0
= 100, K=100, = 25%, r=5%, T=1
Therefore:
Call Price = 12.34 and = 0.63
Nick Motson
11
Delta Hedged Portfolio:
Buy 1 Call Option and Sell 0.63 of asset
73
DELTA
Delta Hedge Example (cont)
If the asset price rises to 101 If the asset price rises to 101
Call Price = 12.97 and = 0.64
Delta Hedged Portfolio:
Profit on long Call = 12.97-12.34 = 0.63
Loss on Short Asset = 0.63
Nick Motson
12
So the Delta hedge worked perfectly, but are we still
hedged?
DELTA
Now = 0 64 so we need to sell another 0 01 of the Now = 0.64 so we need to sell another 0.01 of the
asset at 101.
The delta increases as the price rises and falls as the
price falls so we will be continuously adjusting the
hedge.
Nick Motson
13
Do we make or lose money as we are hedging?
74
DELTA
If the realised volatility over the life of the option is If the realised volatility over the life of the option is
identical to the volatility we used to price the option
and we can continuously adjust our hedge (with no
transactions costs) then the profit we make on our
delta hedging will exactly offset the premium paid
for the option.
Nick Motson
14
GAMMA
Gamma () is defined as the rate of change of delta
() with respect to the price of the underlying asset.
It is the slope of the delta curve. p
i.e. how much does your delta change as the
underlying asset moves.
0
1
) (
option
t S
d N'
= I
o
Nick Motson
15
2
1
2
1
2
1
) (
d
e d N
where
= '
t
75
GAMMA
Gamma of 100 Strike Call vs Price Of Underlying Asset Over Time
0.05
0.06
0.01
0.02
0.03
0.04
G
a
m
m
a
Nick Motson
16
0.00
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
Gamma 1 Year to Expiry Gamma 6 Months to Expiry Gamma 1 Month to Expiry
GAMMA
Long vanilla options have positive gamma &
short option have negative Gamma.
G i t t f ti th t l Gamma is greatest for options that are close
to the money.
imagine the scenario 30 seconds before expiry of a
100 strike call
If the asset price is 99 what is your delta?
Nick Motson
17
76
GAMMA
Hedging gamma is more complex that
hedging delta because the underlying asset
has zero gamma has zero gamma.
Gamma can only be hedged with other
option positions.
Nick Motson
18
VEGA
Vega () is defined as the rate of change of the
value of an option with respect to volatility
i.e. how much does your option price change as
implied volatility moves.
1 0
) (
option
where
T d N S ' = v
Nick Motson
19
2
1
2
1
2
1
) (
d
e d N

= '
t
77
VEGA
Vega of 100 Strike Call vs Price Of Underlying Asset Over Time
0.35
0.40
0.05
0.10
0.15
0.20
0.25
0.30
V
e
g
a
Nick Motson
20
0.00
0.05
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
Vega 1 Year to Expiry Vega 6 Months to Expiry Vega 1 Month to Expiry
VEGA
Long options have positive vega & short
option have negative vega.
V i t t f ti th t l t Vega is greatest for options that are close to
the money
imagine the scenario 30 seconds before expiry of a
100 strike call
If the asset price is 99 what is your vega (do you
Nick Motson
21
If the asset price is 99 what is your vega (do you
want the price to move?)
78
VEGA
As with Gamma, you cannot hedge vega risk
with the underlying asset because the
underlying asset has zero vega underlying asset has zero vega.
Hence vega can only be hedged with other
option positions.
Nick Motson
22
THETA
Theta () is defined as the rate of change of the
value of an option with respect to the passage of
time
the one day passes.
) (
2
) (
2
1 0
d N rKe
T
d N S
rT
call

'
= O

o
Nick Motson
23
) (
2
) (
2
2
1 0
d N rKe
T
d N S
T
rT
put
+
'
= O

o
79
THETA
The theta of a call or put is usually negative. This
means that, if time passes with the price of the
underlying asset and its volatility remaining the y g y g
same, the value of a long option declines.
If you refer back to slides 4 & 5 you should be able
to spot one exception to this rule
Nick Motson
24
THETA
Theta of 100 Strike Call vs Price Of Underlying Asset Over Time
-0 01
0.00
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
0 0
-0.04
-0.03
-0.02
-0.01
T
h
e
t
a
Nick Motson
25
-0.06
-0.05
Asset Price
Theta 1 Year to Expiry Theta 6 Months to Expiry Theta 1 Month to Expiry
80
THETA
Theta of 100 Strike Put vs Price Of Underlying Asset Over Time
0.01
0.02
-0.03
-0.02
-0.01
0.00
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
T
h
e
t
a
Nick Motson
26
-0.05
-0.04
Asset Price
Theta 1 Year to Expiry Theta 6 Months to Expiry Theta 1 Month to Expiry
THETA
Long options have negative theta & short
option have positive theta (with small
exceptions) exceptions).
Theta is greatest for options that are close to
the money
Nick Motson
27
Does hedging theta make sense?
- there is no uncertainty about the passage of time
81
RHO
Rho () is defined as the rate of change of the
value of an option with respect to the interest rate.
interest rates move.
) (
) (
2
d N KT
d N KTe
rT
rT
call
=


Nick Motson
28
) (
2
d N KTe
rT
put
=

RHO
Rho of 100 Strike Call vs Price Of Underlying Asset Over Time
0.80
0.90
1.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
R
h
o
Nick Motson
29
0.00
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
Rho 1 Year to Expiry Rho 6 Months to Expiry Rho 1 Month to Expiry
82
RHO
Rho of 100 Strike Put vs Price Of Underlying Asset Over Time
0 20
-0.10
0.00
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
-0.80
-0.70
-0.60
-0.50
-0.40
-0.30
-0.20
R
h
o
Nick Motson
30
-1.00
-0.90
Asset Price
Rho 1 Year to Expiry Rho 6 Months to Expiry Rho 1 Month to Expiry
RHO
Rho is positive for Calls and negative for puts
with the magnitude increasing as the delta
increases increases.
This is because as rates increase the forward
price will increase (remember lecture 1),
hence calls will increase in price and puts will
decrease
Nick Motson
31
decrease.
83
VOLATILITY VOLATILITY
SMILES
Nick Motson
32
VOLATILITY SMILES
The volatility smile is the relationship
between implied volatility and strike price for
options with a certain maturity options with a certain maturity
The volatility smile for European call options
should be exactly the same as that for
European put options (put call parity)
Nick Motson
33
The volatility surface is the relationship
between implied volatility across strike prices
and time to maturity.
84
VOLATILITY SURFACE
Nick Motson
34
VOLATILITY SMILES
For equity options lower strike price
volatilities are much higher than the higher
strike price volatilities hence the smile strike price volatilities, hence the smile
Implied
Volatility
Nick Motson
35
Strike
Price
85
VOLATILITY SMILES
You will recall that the Black Scholes model
assumes that prices are distributed lognormally.
In reality the distribution does not look like this.
The empirical distribution has a fatter left tail (nigher
probability of a big downmove)
The key issue is that Black-Scholes does not
d t i ti i th k t d th t
Nick Motson
36
determine option prices, the market does that.
Black-Scholes is simply a sophisticated model
that approximates (very well) market prices.
VOLATILITY SMILES
Given the implied volatilities we can infer the
implied distribution of stock prices.
Implied Distribution
L l Di t ib ti
Nick Motson
37
Lognormal Distribution
86
VOLATILITY SMILES
Further Explanations
Asset price exhibits jumps rather than
continuous changes
Volatility for asset price is stochastic
In the case of equities volatility is negatively related
Nick Motson
38
q y g y
to stock prices (prices move up slowly and down
quickly). This is consistent with the skew that is
observed in practice
VOLATILITY SMILES
The volatility term structure is much simpler.
It tends to be downward sloping when volatility
is high and upward sloping when it is low
This implies that there is a long term average
volatility.
Nick Motson
39
87
VOLATILITY SMILES
Implications of the volatility smile
Using a flat volatility surface is flawed and
d b it d t fl t th t dangerous because it does not reflect the true
distribution of the underlying asset
Under value out of the money puts (portfolio
insurance)
Underestimate the delta of out of the money
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40
Underestimate the delta of out of the money
options (under hedged)
EXOTIC EXOTIC
OPTIONS
Nick Motson
41
88
EXOTIC OPTIONS
There are literally dozens of different exotic
options, however we will focus on only the 4
main categories that are relevant to the main categories that are relevant to the
structured products we will cover in this course
(we could spend 10 weeks just covering exotic options)
Barrier Options
Binary Options
Nick Motson
42
Asian Options
Basket Options
EXOTIC OPTIONS
When modelling exotic options, one has to
make a fundamental decision very early in the
process: should you model the option in a process: should you model the option in a
continuous-time, Black-Scholes type of model,
or in a binomial model.
Generally many exotic options are initially priced via a binomial
model, and then at some point traders figure out a closed-form
pricing model.
Sometimes it turns out that no closed form solution is ever
Nick Motson
43
Sometimes, it turns out that no closed form solution is ever
found.
Indeed, for certain highly path-dependent options, one cannot
even work backwards in a lattice, instead one must use a
Monte-Carlo method to value the option.
89
EXOTIC OPTIONS
In this course you are NOT expected to
be able to produce models to price exotic
options. You ARE however expected to
understand:
The payoff diagrams of exotic options
Whether the price of the exotic is higher or lower
than the vanilla option
Nick Motson
44
The reasons for using exotic options and the
inherent risks
The factors that drive the options price
EXOTIC OPTIONS
Nick Motson
45
90
BARRIER OPTIONS
Barrier options are options that have a payout
that is dependent not only on the terminal stock
price, but also depend upon whether the stock price, but also depend upon whether the stock
attains some barrier during the life of the
option. Two general kinds:
Knock-out options: The option ceases to exist if the
stock reaches a given barrier during the options life.
Nick Motson
46
Knock-in options: The option comes into being only if
the stock reaches a given barrier during its life.
Up & Out Call, Strike 100, Barrier 130
30
35
BARRIER OPTIONS
10
15
20
25
30
Nick Motson
47
0
5
50 60 70 80 90 100 110 120 130 140 150
91
BARRIER OPTIONS
Down & Out Put Strike 100, Barrier 70
30
35
10
15
20
25
30
Nick Motson
48
0
5
50 60 70 80 90 100 110 120 130 140 150
BARRIER OPTIONS
Up & In Call Strike 100, Barrier 130
60
20
30
40
50
Nick Motson
49
0
10
50 60 70 80 90 100 110 120 130 140 150
92
BARRIER OPTIONS
Down & In Put Strike 100, Barrier 70
60
20
30
40
50
Nick Motson
50
0
10
50 60 70 80 90 100 110 120 130 140 150
BARRIER OPTIONS
UP & IN CALL + UP & OUT CALL = CALL
+
Nick Motson
51
=
93
BARRIER OPTIONS
Closed form solutions exist for the pricing of
barrier options (see Hull) though due to
stochastic volatility Monte Carlo simulations stochastic volatility Monte Carlo simulations
might also be used.
The Greeks (we will only really cover ) are a
little more complex, see next slide
Nick Motson
52
BARRIER OPTIONS
Value Of an UP & OUT Call, Stirke 100, Barrier 130
25.0
30.0
5.0
10.0
15.0
20.0
V
a
l
u
e
Nick Motson
53
0.0
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
1 Year to Expiry 6 Month to Expiry 1 Month to Expi ry At Expiry
94
BARRIER OPTIONS
Recall that Delta is the slope of the value vs
underlying asset line.
For an up & out call the delta is not always
positive (sometimes the line has negative
slope), this is very different from a vanilla call.
This is because as we approach the barrier
there is a higher likelihood that the option will
Nick Motson
54
there is a higher likelihood that the option will
be knocked out which will result in a zero
payoff and hence the value falls.
BARRIER OPTIONS
Value Of UP & IN Call, Stirke 100, Barrier 130
40.0
45.0
50.0
5 0
10.0
15.0
20.0
25.0
30.0
35.0
V
a
l
u
e
Nick Motson
55
0.0
5.0
5
0
6
0
7
0
8
0
9
0
1
0
0
1
1
0
1
2
0
1
3
0
1
4
0
1
5
0
Asset Price
1 Year to Expiry 6 Month to Expiry 1 Month to Expi ry At Expiry
95
BINARY OPTIONS
A Binary Option is basically a standard option,
but one in which the payout is altered such that
it only pays a fixed amount if the option ends it only pays a fixed amount if the option ends
up in the money.
In a cash or nothing binary, the amount is a lump
sum.
In an asset or nothing binary the payoff is the
Nick Motson
56
In an asset or nothing binary the payoff is the
asset if the option ends in the money.
BINARY OPTIONS
Binary Cash or Nothing Call, Strike 100
90.00%
100.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
Nick Motson
57
0.00%
10.00%
20.00%
50 60 70 80 90 100 110 120 130 140 150
96
BINARY OPTIONS
Binary Cash or Nothing Put, Strike 100
90.00%
100.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
Nick Motson
58
0.00%
10.00%
20.00%
50 60 70 80 90 100 110 120 130 140 150
BINARY OPTIONS
Binary Asset or Nothing Call, Strike 100
130
140
150
40
50
60
70
80
90
100
110
120
130
Nick Motson
59
-
10
20
30
40
50 60 70 80 90 100 110 120 130 140 150
97
BINARY OPTIONS
Binary Asset or Nothing Put, Strike 100
130
140
150
40
50
60
70
80
90
100
110
120
130
Nick Motson
60
-
10
20
30
40
50 60 70 80 90 100 110 120 130 140 150
ASIAN OPTIONS
The term Asian Option means an option where
the payoff to the option is a function of the
average price of the underlying for some average price of the underlying for some
portion of the life of the option
There are actually many variants of Asian options available.
Average price call: max(0,S
ave
-K)
Average price put: max(0,K-S
ave
)
The method for calculating the average can vary.
Usually it is the arithmetic average but can be the geometric
Nick Motson
61
Usually it is the arithmetic average, but can be the geometric
average.
If arithmetic average, usually no closed form solution exists,
although Hull presents some approximations. Typically will rely
upon Monte Carlo procedures to determine the value.
98
ASIAN OPTIONS
The period of from which the average is taken
can vary tremendously:
Daily over life of the option Daily over life of the option.
Daily over last n days of options life.
Daily over first n days of options life.
Weekly, monthly, etc.
From specific days during the life of the option
Nick Motson
62
As the volatility of the average is lower than
that of the spot itself, the price of Asian options
are generally lower than the European ones
BASKET OPTIONS
As its name suggests a Basket Option is simply
an option on a basket of assets, a common
example is an equity index option example is an equity index option.
How does the price of an index option relate to the
movements of the underlying stocks?
Hopefully by now you will know that the option price is
Nick Motson
63
Hopefully by now you will know that the option price is
related to the volatility of the underlying asset
99
BASKET OPTIONS
The volatility of the basket can be approximated
from the individual volatilities of the assets in
the basket & their correlations the basket & their correlations
as long as the correlations are less that 1, then the volatility of the
basket will be lower than the weighted average of the individual
underlying assets.
j i j i
j i
j i basket
w w o o o
,
,
2
~
Nick Motson
64
Hence the option on the basket is cheaper than
the sum of options on each individual underlying
BASKET OPTIONS
The payoff of a basket option does not always
have to be related to the performance of the
basket, there are also Best Of and Worst Of basket, there are also Best Of and Worst Of
Options (sometimes these are referred to as
rainbow options).
A Best Of option pays the difference between the
best performing asset in the basket and the strike
price
Nick Motson
65
p
A Worst Of option pays the difference between
the worst performing asset in the basket and the
strike price
100
BASKET OPTIONS
Once again the price of Best Of and Worst Of
Options depends on both the volatilities and the
correlations of the basket components correlations of the basket components
General idea is that when the correlation is low
(or even negative) there is a more diverse
range of outcomes, hence there will always be
one asset which has outperformed and one that
Nick Motson
66
one asset which has outperformed and one that
has under performed (think about the case of perfect
negative correlation).
BASKET OPTIONS
The effect of volatility is obvious (hopefully), the
effect of correlation on best of and worst of
options is summarised in the table below
Call Put
Best Of - +
Worst Of + -
options is summarised in the table below
Nick Motson
67
101
BASKET OPTIONS
Best Of and Worst Of Options are used
extensively in structured products to make them
look more attractive look more attractive.
For example:
Buying a best of option provides the opportunity
to benefit from the best payout of a group of
underlying assets, at a lower cost than buying
individual vanillas of all the underlying assets
Nick Motson
68
separately
EXOTIC OPTIONS SUMMARY
You Get You Get
What You
Nick Motson
69
Pay For!
102
HOMEWORK THIS WEEK
Compulsory
The Bloomberg article (1 pages) do you agree with the advice?
Imagine that the FTSE is currently at 5,000. Your view is that over the next
year it will most likely rally by 10%, but there is also a chance of a 10% year it will most likely rally by 10%, but there is also a chance of a 10%
selloff.
Can you come up with 3 strategies to express this view using vanilla and
exotic options, draw payoff diagrams and explain the risks and rewards
versus just buying the index.
There is a spreadsheet on CitySpace that prices vanilla and exotic options
for you.
(Assume an interest rate of 4%, volatility of 25% and a dividend yield of 1.5%)
Optional
Nick Motson
70
Optional
Chapter 14 The Greek Letters
Chapter 15 Volatility Smiles
Chapter 19 Exotic Options
103
Lecture 4 Introduction to
d d & i Structured Products & Basic
Equity Structured Products
Nick Motson
1
"Optimism.. is the enemy of the rational buyer"
Warren Buffet.
104
INTRODUCTION
Over the last 3 weeks we have covered all of
the main building blocks for structured products
B h ld b f ili ith By now you should be familiar with
Forwards and futures
Vanilla Options
Exotic Option
This week we will cover the basics of structured
Nick Motson
2
This week we will cover the basics of structured
products including some examples
A structured product is a security that combines the
features of a fixed income instrument or a short-term
deposit with the risk and return characteristics of
WHAT ARE STRUCTURED PRODUCTS?
deposit with the risk and return characteristics of
embedded derivative contracts.
Structured products pay a return linked to the
performance of an underlying benchmark such as
interest rates, equity markets, commodities, corporate
credits or foreign exchange markets
Nick Motson
3
credits or foreign exchange markets.
105
In the early/mid 90s products were mainly warrants &
option strategies. Listed markets represented most of the
volume A normal player would issue one Note and about
MARKET DEVELOPMENT
volume. A normal player would issue one Note and about
10 warrants per month.
Today, IT & model developments have lead to a dramatic
increase in activity. There are at least 5-10 major
structured product players
Scores of issues everyday 10 to 15 billion per year per country
Nick Motson
4
Scores of issues everyday, 10 to 15 billion per year per country,
billions of stocks.
Structured products represent 10% of AUM in Private Banking.
In a low interest rate environment, earning a respectable
rate of return became increasingly difficult. Structured
notes offer the potential for greater returns than
prevailing market interest rates. Yield enhancement is
hi d i t b lli ti
WHY ARE THEY SO POPULAR?
achieved in most cases by selling options
By combing option contracts in varying degree to
deposits or fixed income instruments, customized risk-
return profile and leverage can be tailored to different
investors.
Nick Motson
5
The decrease in the size of note denomination has
allowed retail investors to participate. Capital protected
products are particularly popular amongst retail investors
in Asia and Europe.
106
An alternative explanation for the popularity of structured
products is that investors face regulatory constraints &
WHY ARE THEY SO POPULAR?
structured notes are a way round them.
Constraints on asset classes
Constraints on derivatives (most structured products are bonds)
Constraints on risking capital
Nick Motson
6
WHAT PRODUCTS ARE AVAILABLE?
Equity Linked Notes
Index Linked Notes, Notes linked to baskets of equities or
individual stocks
Interest-Rate Linked Notes
Callable, Capped Floaters, Reverse Floaters, Range Accruals,
CMS-linked
FX Linked Notes / Yield Enhanced Deposits
Dual-Currency Notes, Corridors, FX Range Accrual Notes,
Fund Linked Notes
Nick Motson
7
u d ed otes
Mutual Fund, Hedge Fund
Commodity Linked Notes, Inflation, Weather
Anything as long as there is an underlying index
107
TWO MAIN PRODUCT CATEGORIES
INDEX / GROWTH PRODUCTS
With or without capital guarantee
Purchase of options to gain exposure on an
underlying.
YIELD / REVENUE PRODUCTS
Use of options paying a pre-defined performance if a
Nick Motson
8
pre-announced scenario materialises
Either purchase of binary options (predefined
maximal value) or the sale of options (premium paid
when the product is issued)
EXAMPLE PRODUCT
Nick Motson
9
108
Financial engineering of a structured issue
Euribor + funding Euribor + funding
WHO DOES WHAT?
I ssuer
Bank
Sales
Trading book
Markets
Issue price
Redemption
+ structured coupon
Structured
coupon
Structured
coupon
Hedge
Nick Motson
10
Structuring
Trading
I nvestors
Sales
CHRONOLOGY OF EVENTS
Primary
Market
Price = 100%
Grey
Market
Price varies
Issue
d
Fixing
i
Payment
l
Redemption
f i
Secondary market
Market-making by
The bank
Nick Motson
11
Products
creation
Setting
of the initial
level
of the
reference
index
Settlement
of the product
After Setting
of the final level
of reference index
109
STRUCTURED PRODUCTS ARE NOT ROCKET
SCI ENCE
All of the products we
will examine over the
coming sessions are coming sessions are
simply combinations of
the instruments we have
covered in weeks 1-3 in
some sort of wrapper.
Nick Motson
12
WRAPPERS
A wrapper is the legal structure within which a
structured product is issued. The following
criteria are considered when choosing a criteria are considered when choosing a
wrapper
- Cost and speed of issuance
- Secondary market/Liquidity
- Market practice
Nick Motson
13
- Tax treatment
110
WRAPPERS
The most popular wrapper is the Medium Term Note
(MTN)
An MTN is a security whose payoff is linked to the underlying asset. It y p y y g
provides a low cost and simple wrapper for the product to sit within.
Notes are issued from a Note Issuance Programme. This Programme will
have a Base Prospectus from which the MTNs are structured. This Base
Prospectus provides the issuing platform from which individual MTNs can be
created. It provides all the definitions and legal structures for each MTN
issued from the Programme.
Each MTN that is issued will have its own Note Supplement. This Note
Supplement gives the details of the MTN, giving each defined term, from the
Base Prospectus, a value specific to this MTN.
MTNs are generally settled on either the Euroclear or Crest settlement
Nick Motson
14
MTNs are generally settled on either the Euroclear or Crest settlement
systems, this allows for an easy and quick transfer of ownership of the
security.
This wrapper exposes the investor to credit risk on the issuer
WRAPPERS
Though MTNs are the most popular wrapper there are
many other possibilities
Warrants &Certificates Warrants & Certificates
Very similar to MTNs, often listed on an exchange. Again exposes
investor to the credit risk of the issuer.
Structured Deposits
A bank deposit whose maturing value reflects the payoff of the
structured product upon maturity. Removes credit risk but only
banking institutions can issue.
Funds
A fund whose investment objective is to replicate a structured product
payoff This is costly to administer
Nick Motson
15
payoff. This is costly to administer.
Over The Counter contracts (OTC)
A bilateral contract usually confirmed under ISDA (International Swaps
and Derivatives Association) framework. Not suitable for retail clients.
111
EXAMPLE TERM SHEET
Nick Motson
16
112

3 Year EUR 100% Capital Protected Certificate
Linked to the Eurostoxx 50 Index
ISIN: XS0366495777
Final Terms and Conditions (as of 09 June 2008)
Description of the Product
The Securities provide exposure to the performance of the Eurostoxx 50 Index along with 100% principal protection at
maturity.
General Terms:
Issuer Merrill Lynch S.A. with registered offices at 4, Rue Albert Borschette, L- 1246,
Luxembourg
Guarantor Merrill Lynch & Co. Inc., Wilmington, Delaware 19801, USA
(Long term senior unsecured debt rating: S&P A, Moodys A1, Fitch A+)
Manager Merrill Lynch International
Calculation Agent Merrill Lynch International, 2 King Edward Street, London
Principal Security Agent BNP Paribas Securities Services S.A., Zweigniederlassung Frankfurt am Main,
Grneburgweg 14, 60322 Frankfurt am Main
Security Codes ISIN: XS0366495777 Common Code: 36649577
Valor: 4261804 Symbol: SAVER
Type of Security Certificate
Timetable:
Subscription Period Until 5 June 2008, 5 p.m. CET (The subscription period might close earlier if max.
size is reached or market conditions force it)
Trade Date 6 June 2008
Reference Pricing Date 6 June 2008
Issue Date 17 June 2008
Exercise Date 6 June 2011
Settlement Date 20 June 2011
Specific Terms:
Name Bloomberg Code Initial Index Level Underlying
Eurostoxx 50
Index
SX5E Index 3596.70
Settlement Currency EUR
Issue Value 100%
Aggregate Principal Amount EUR 5,500,000
Nominal Amount EUR 1,000 per Security (= Denomination)
Ratio 1 Security entitles to one times the Settlement Amount on the Final Settlement
Date
Min. Redemption 100%
Participation 100%
The terms outlined herein represent a summary of the terms and conditions of the Securities. The full legally binding terms and conditions for the Securities will be contained in the relevant Offering
Documents for the Certificate Programme of the Issuer. The Offering Documents will be made available upon the issuance of the Securities.

ISIN: XS0366495777
Settlement Amount on the Final
Settlement Date
The Redemption per Denomination will be in cash according to the following formulae:
Denomination x
Initial
Initial Final
SX5E
SX5E SX5E
* 100.00% 0; Max % 100
where
SX5EInitial is the official closing price of the Underlying Index on Initial Valuation Date
SX5EFinal is the official closing price of the Underlying Index on Final Valuation Date
Additional Provisions:
Secondary Market Merrill Lynch International will provide a daily secondary market on a best effort
basis under normal market conditions.
Governing Law English Law
Place of Jurisdiction English Courts
Listing Application will be made to list the Certificates on the SWX Swiss Exchange
Clearing Euroclear and Clearstream
Settlement Method Cash
Automatic Exercise Applicable
Minimum Exercise Amount 1 Security
Business Days London and Target
Form of Securities Bearer
Minimum Investment Amount 1 Security
Day Count 30 / 360

Quotes / Information:
Internet www.mlinvest.ch
Source of Information This simplified prospectus can be obtained free of charge at Merrill Lynch Capital
Markets AG, Zurich, Switzerland
Reuters XS036649577=MERL
Bloomberg ID XS0366495777 <GO> (ALL Q)

Risk for investors:
Product-specific risks
The securities described herein are derivative financial instruments. The securities
offer 100% principal protection at maturity. Investors should bear in mind that the
100% principal protection feature of this security is subject to the credit risk of the
Issuer.
Issuer risk The investment instruments value is dependent not only on the development of
the underlying, but also on the creditworthiness of the issuer, which may vary over
the term of the structured product.

113

ISIN: XS0366495777
Tax Provisions:
Swiss Federal Stamp Duty Secondary market transactions are subject to Swiss stamp duty at a current rate of
up to 0,3 %.
Swiss Federal Income Tax For private investors residing in Switzerland and holding the Security as a private
asset any increase in the value of the bond part when sold before maturity, called
by the Issuer before maturity or redeemed at maturity (calculated according to the
so-called "Modifizierte Differenzbesteuerung"), is subject to the Swiss Federal
Income Tax.
Bondfloor The present value of the bond part at issue is EUR 856.74 per unit. The value of
the bond part at maturity will be EUR 1,000 per unit.
Swiss Withholding Tax Payments under the Security are not subject to Swiss withholding tax.
EU Savings Tax Directive For Swiss paying agents, payments under the Security are not subject to the EU
savings tax (TK2).

Supervision:
Merrill Lynch Capital Markets
AG
Is a Swiss licensed bank, a securities dealer and a member of the Swiss
Exchange and Virt-X. As a Swiss Bank it is regulated by the Swiss Federal
Banking Commission.
Merrill Lynch International Is Authorised and Regulated by the Financial Services Authority. Member of the
London Stock Exchange
Merrill Lynch S.A. (MLSA) The Issuer is a Luxembourg limited company. The Issuer was incorporated on
18th December, 1991 as a socit anonyme for an unlimited period. The Issuer
complies with the Luxembourg corporate governance regime. MLSA is not a
regulated or supervised entity.

Important Information for Swiss Investors:
The Securities are qualified as structured products, not as collective investment schemes in terms of the Swiss Federal Act on Collective Investment
Schemes (CISA), and the Securities are neither subject to the approval nor to the supervision of the Swiss Federal Banking Commission.
The Securities constitute direct, unsubordinated, unconditional and unsecured obligations of MLSA and will rank equally with MLSA.'s other direct,
unsubordinated, unconditional and unsecured contractual obligations. However the Securities are subject to an unconditional and irrevocable
guarantee from Merrill Lynch & Co. Inc. (ML&CO)
The insolvency of MLSA may lead to a partly or total loss of the invested capital.
The Securities are not issued or guaranteed by a bank.
The proceeds of these Securities will be used for general corporate purposes

Sales Restrictions:
United States. The Securities will not be registered for public sale in any jurisdiction and so will be available only in accordance with applicable,
available, private offering rules. The security described herein is not for sale in the U.S. or to U.S. persons and this communication may not be
distributed in the U.S.
Although a Prospectus (as defined in the EU Prospectus Directive 2003/71/EC (Prospectus Directive)) has been prepared in connection with the
Securities and approved by the competent authority in Switzerland, the Prospectus has not been notified to the competent authority of any
European Economic Area (EEA) member state and any purchaser of the Securities who subsequently sells any of their Securities in any such EEA
member state must do so only in accordance with the requirements of the Prospectus Directive as implemented in such member state.

Re-Distribution:
In connection with the offer and sale of the Securities, the distributor will acquire the Securities from the Lead Manager at a discount to the issue

ISIN: XS0366495777
price or at the issue price. If the distributor acquires the Securities at the issue price, the Lead Manager will pay to the distributor a distribution fee.
Such amounts received by the distributor may be in addition to the brokerage cost/fee normally applied by the distributor. The purchaser
acknowledges that such distribution fee may be retained by the distributor. Further information is available from the distributor on request.

Disclaimers:
Fees and commissions are payable in relation to this product. Details of those fees and commissions are available upon request.
This communication does not contain a complete description of the Securities and the risks associated with an investment therein, and are subject
to and qualified in their entirety by reference to the Offering Documents.
This Term Sheet contains indicative terms only. All materials contained herein are for discussion purposes only. Finalised terms and conditions are
subject to further discussion and negotiation. We make no representation and have given you no advice concerning the appropriate accounting
treatment or possible tax consequences of this indicative transaction.
This communication is furnished at the request of the recipient for the exclusive purpose of identifying the nature of the security or other instrument
referred to herein. It is furnished for your private information with the express understanding, which the recipient acknowledges, that it does not
constitute an offer of such security or a means by which such security may be offered or sold. The terms outlined herein are indicative only and are
subject to change. While we consider the information herein reliable, we do not represent that it is accurate or complete and it should not be relied
upon as such. Any written offer of such security may be made only by means of the Offering Documents or similar document and any related
supplements thereto. The security referred to herein may involve a high degree of risk, which may include principal, interest rate, index, currency,
credit, political, liquidity, time value, commodity and market risk and is not suitable for all investors. We or our affiliates may buy or sell securities or
have long or short positions in securities economically related to any security mentioned herein. We or our affiliates may have an investment
banking or other commercial relationship with the issuer of any security mentioned herein.
Merrill Lynch International will not be responsible for the consequences of reliance upon any statement or information contained herein or any
omission herefrom. We make no representation and have given you no advice concerning the appropriate accounting treatment or possible tax
consequences of this indicative transaction. Investors should consult their own investment, tax and other professional advisors before investing in
the Securities.
The Securities have not been registered for public sale in any jurisdiction and are therefore available only in accordance with applicable private
offering rules. This means that the Securities may not be available in all jurisdictions or may be available to a limited number of qualifying investors
only. This indicative term sheet is intended for your personal use and you must not give it or show it to any other person.
Notice for UK Investors: The Issuer does not have a place of business in the United Kingdom and is not regulated by the UK Financial Services
Authority. As a consequence, the regulatory regime governing your rights as an investor in respect of the Issuer (and its similarly unauthorised,
overseas agents and affiliates) will be different to that of the United Kingdom. The UK rules for the protection of private investors and the UK
Financial Compensation Scheme will not apply in respect of such entities, although if your securities account is serviced from the UK by Merrill
Lynch International Bank Limited, the normal UK protections will apply in relation to the services that it provides. Approved for issue in the UK by
Merrill Lynch, Pierce, Fenner & Smith Limited, Merrill Lynch Financial Centre, 2 King Edward Street, London EC1A 1HQ.

114
READING THE TERM SHEET
The Term Sheet is a legal document and as such is
often not easy to read
The Following Terms MUST be defined
The Issuer/Guarantor and the Credit Rating
The Wrapper
Issue and Maturity Dates
The Underlying and The Currency
Nick Motson
17
Any Capital Guarantee/Protection and Participation
The Payoff Equation
+ Many Legal & Regulatory requirements
Issuer/ Guarantor and Credit Rating
The Investor is lending money to the issuer by
purchasing the note and hence is accepting the credit
risk of the issuer. The issuer is not always the same
institution as the one selling the product Prior to the
Nick Motson
18
institution as the one selling the product. Prior to the
recent credit crisis little attention was paid to the issuer
as long as they were an AA or possibly A+ rated bank.
Now everybody pays close attention to the issuer!
115
The Wrapper
As already mentioned the type of wrapper may have tax
implications.
Issue and Maturity Dates
Nick Motson
19
Hopefully this is fairly self explanatory.
In this case the underlying is a European equity index
and the note is denominated in Euros so they match.
This is not always the case.
think of a European investor who wants exposure to emerging
market equities but does not want the currency risk.
Nick Motson
20
116
Capital Guarantee/ Protection and
Participation
In this case the minimum redemption is 100% so the note is
termed 100% capital protected this is not always the case
& is an important component of the price.
In this case the participation is 100% of the rise in the
underlying index again this is not always the case
Nick Motson
21
underlying index, again this is not always the case
Could be less or more than 100%
Could be capped or floored
Could be conditional upon certain events/barriers
The Payoff Equation
Clearly this is one of the most important terms but is
not always user friendly and needs translating
Nick Motson
22
at maturity you will receive 100% of your money back plus
100% of any rise in the Eurostoxx 50 index
117
REVERSE ENGINEERING THE PRODUCT
Draw The Payoff Diagram
3 Year EUR 100% Capital Protected Certi fi cate
Li nked to the Eurostoxx 50 Index
100
110
120
130
140
150
R
e
d
e
m
p
t
i
o
n

P
r
o
c
e
e
d
s
Nick Motson
23
80
90
1798.35 2158.02 2517.69 2877.36 3237.03 3596.7 3956.37 4316.04 4675.71 5035.38 5395.0
R
Eurostoxx 50 Index
CAPITAL GUARANTEEDEQUITY CAPITAL GUARANTEED EQUITY
LINKED NOTE
ZERO COUPON
BOND
=
+
Nick Motson
24
LONG CALL OPTION
118
?
Schematic Representation Of A 100% Capital Guaranteed Growth Product
Zero
Coupon
Bond
100
Option
Premium
Z
e
r
o

C
o
u
p
o
n
O
p
t
i
o
n
Nick Motson
25
Bond
n

B
o
n
d
AT
INCEPTION
AT
MATURITY
The Zero Coupon Bond
The zero coupon bond has to provide a payoff at maturity
equal to the level of the capital guarantee, in this case
100%. The appropriate discount rate for the bond is
determined by the credit risk of the issuer. The rate can be
found by examining comparable bonds of a similar maturity
If we assume that the appropriate rate in this case is 6.75%
(annual continuous compounding) how much is the zero
Nick Motson
26
(annual continuous compounding) how much is the zero
coupon bond worth?
119
The Zero Coupon Bond
Think back to lecture 1
PV = 100 x e
-rt
= 100 x e
-(0.0675 x 3)
= 81.67
Nick Motson
27
= 81.67
The Option
Think back to lecture 2
The option has to provide a payoff equal to 100% of the
increase in the Eurostoxx50 index above 3596.7.
This is just a plain vanilla call option:
Option Type: European
Strike: 3596.7
Sta t Date 6
th
J ne 2008
Nick Motson
28
Start Date: 6
th
June 2008
Maturity: 6
th
June 2011
We can price this using Black-Scholes
120
The Option
For
every
100 of
the
product
we are
Nick Motson
29
we are
buying
options
worth
17.77
FOR THE ISSUER
CAPITAL GUARANTEED EQUITY
LINKED NOTE
100
ZERO COUPON
BOND
81.67
CALL OPTION
=
+
Nick Motson
30
17.77
PROFIT
0.56
+
121
POINTS TO PONDER
Would You Buy This Product?
What are the alternatives
Is It Too Good To Be True?
There is NO Free Lunch here
What Are The Moving Parts?
Nick Motson
31
at e e o g a ts
How could you vary the structure
FACTORS AFFECTING THE PRICE
PRIMARY MARKET
Interest rates
Hi h t l i t Higher rates, less in zero coupon, more money to
buy options gives more participation
Volatility
Increased vol means more expensive options and so
less participation in growth products
Nick Motson
32
less participation in growth products
122
SECONDARY MARKET
Interest rates
Rising rates, value of zero falls thus product price
f ll (j t lik b d) falls (just like any bond)
Volatility
Increase in volatility means options become more
expensive. If long options then the product price
rises
Underlying
Nick Motson
33
Underlying
Product WILL move with the under lying BUT even
if participation is 100% product the change will
NOT be 100% (think back to weeks 2 & 3 ).
HOW DID THIS PRODUCT PERFORM?
Nick Motson
34
123
THE ART OF STRUCTURING
The example product we have examined so far was
extremely simple and as such attractive to investors, the
key elements were: key elements were:
100% capital protection
100% participation
The market conditions in June 2008 meant that it was
Nick Motson
35
possible to put together the component parts for a cost
that was less than 100. Unfortunately this is rarely the
case and hence structuring becomes more complex.
The art of structuring is putting together component
parts that sum to less than the cost of the product and
provide a payoff profile that is still attractive to investors provide a payoff profile that is still attractive to investors
Vary the level of capital protection?
Vary the option payoff?
Nick Motson
36
124
Many investors demand 100% capital protection and
hence a lot of the focus is on varying the option payoff.
At the same time there is a psychological issue with
offering less than 100% participation, so other ways
have to be found to cheapen the option.
Remember lectures 2 & 3?
Nick Motson
37
Cap Performance
Knock-outs
Baskets
Asian Options
EXAMPLE TERM SHEETS
1. Deutsche 100% Capital Protected Note on DAX
with 100% Participation and 124% Cap
2 Deutsche Shark Note linked to the Dow Jones EURO 2. Deutsche Shark Note linked to the Dow Jones EURO
STOXX 50 with 100% capital protection, 150%
Barrier and 6% Rebate
3. SocGen Protected Local Cap on Basket of Emerging
Market Indices
4. RBC MTN linked to the performance of the Dow
Jones Industrial Average
Nick Motson
38
Jones Industrial Average
5. Abbey Guaranteed Growth Plan (Issue 27)
Stockmarket Option
125
1 100% Capital Protected Note on DAX
with 100% Participation

and 124% Cap
Final Termsheet
Product Description
This 100% Capital Protected Note is a EUR denominated Security with a lifetime of three years. It is linked to
the Performance of the XETRA DAX
. At maturity, the investor receives a minimal reimbursement of 100% of

the Nominal Amount of EUR 1,000 per Security regardless of the Performance of the Underlying during the
lifetime of the Security. Additionally, the investor participates in 100% of the Performance of the Underlying up
to 124%.
This Security is appropriate for investors who expect a positive Performance of the Underlying during the
lifetime of the Security but who want to minimize the risk of loss of the invested capital.
Final Terms and Conditions
July 2, 2008
Issuer Deutsche Bank AG, Frankfurt (S&P: AA, Moodys: Aa1)
Issue Volume Up to EUR 20,000,000
Nominal Amount EUR 1,000 per Security
Issue Price 100% of the Nominal Amount
Name of the Underlying
Initial Reference
Level (IR)
Cap
XETRA DAX
Valor: 846900
RIC: .GDAXI
ISIN: DE0008469008
6305.52
124% of the Nominal
Amount
Participation Factor 100%
Capital Protection 100% of the Nominal Amount
Subscription Period From June 25, 2008 to July 2, 2008, 3 p.m. (CET)
Initial Valuation Date July 2, 2008
Payment Date July 9, 2008
Expected beginning of
Trading on the SWX
July 9, 2008
Index XETRA DAX
Index Sponsor Deutsche Brse AG

Last Trading Day July 1, 2011
Final Valuation Date July 1, 2011
Settlement Date July 8, 2011

and 124% Cap
Final Termsheet
Settlement Cash
Initial Reference Level
(IR)
The official closing price of the Underlying on the Initial Valuation Date
Final Reference Level
(FR)
The official closing price of the Underlying on the Final Valuation Date
Performance (P) (Final Reference Level Initial Reference Level) / Initial Reference Level; in
case of multiple Underlyings, the formula for the Performance is as follows:
i
i i
i
IR
IR FR
w P
Where i is the constituent of the Underlying.

Redemption On Settlement Date, the investor is entitled to receive:
a) If the Performance of the Underlying multiplied by the Participation
Factor is at or above the Cap, 100% of the Nominal Amount plus an
amount equal to the Cap.
b) If the Performance of the Underlying multiplied by the Participation
Factor is below the Cap, 100% of the Nominal Amount plus a an
amount equal to the Performance multiplied by the Participation
Factor.
As a formula:
100% of the Nominal Amount + Max (0; Min (Cap; Participation Factor X
Performance))
The redemption cash amount will be rounded to the nearest two decimal
places, 0.005 being rounded downwards. The redemption cash amount will be
paid out in EUR and will not be less than 100% of the Nominal Amount per
Security.
Minimum Subscription/
Trade Size
1 Security
Tax
No Swiss withholding tax. No Swiss federal stamp duty at issuance (primary
market). Swiss federal turnover stamp duty on secondary market transaction.
This Security is classified as transparent (IUP = Interest Unique Predominant).
The difference between the Capital Protection and its present value (EUR
1000 EUR 854.81 = EUR 145.19, IRR 5.3685%) is classified as interest
income and subject to Swiss income tax for individuals having their tax
residence in Switzerland and holding the Security as part of their private
property. The afore mentioned tax treatment is valid at the time of launch of
the issue and is not exclusive. The relevant tax laws and the administrative
practice are subject to change. Deutsche Bank AG expressly excludes all
liability in respect of any tax implications.
EU Savings Tax
Treatment
For Swiss paying agents, this Security is not in scope (TK2).
126

and 124% Cap
Final Termsheet
Governing
Law/Jurisdiction
ENGLISH LAW/ LONDON
Clearing Agent SIS SegaInterSettle
Calculation and Primary
Paying Agent
Deutsche Bank AG, Frankfurt
Secondary Paying Agent Deutsche Bank AG, Zurich branch
Listing Application will be made for listing on the SWX Swiss Exchange.
Selling Restrictions United States, US Persons, the United Kingdom, European Economic Area,
Canada, Japan
Market Making Under normal market conditions, it is forseen that Deutsche Bank AG,
Frankfurt will quote bid/offer prices for this Security on the SWX Swiss
Exchange.
SVSP Product Type 450 Capped Capital Protection
ISIN DE000DB3QCX1
Valor 4274405
Symbol CPDDB

and 124% Cap
Final Termsheet
Disclaimer
Security Risks: The Securities are derivative financial instruments. This security has a capital protection of 100%.
Issuer Risk: The investors bear the credit risk of Deutsche Bank AG as Issuer of the Securities. The value of the Securities depends not
only on the Performance of the Underlying but also on the solvency of the Issuer, which may vary over the lifetime of the Securities. The
Securities are unsubordinated, unsecured contractual obligations of the Issuer. They do not benefit from any preference in rank. The
insolvency of the Issuer may lead to a partial or total loss of the invested capital.
This document contains a short summary description of the most relevant terms and conditions of the above-described Securities (the
"Securities"). The complete terms and conditions are included in the Offering Circular. The facts contained herein are merely for information
purposes. This document, and the information contained therein, does not constitute an issue prospectus according to the articles 652a and
1156 of the Swiss Code of Obligations ("CO"). Only the terms and conditions included in the Offering Circular, which can be obtained free of
charge at Deutsche Bank AG, Zurich branch, X-markets, Postfach 3604, 8021 Zurich, are binding.
The Securities are not collective investment schemes pursuant to the Swiss Collective Investment Schemes Act ("CISA") and are, therefore,
not subject to authorisation by the Swiss Federal Banking Commission.
In connection with the offer and sale of the Securities, the distributor may acquire the Securities from the Issuer at a discount to
the Issue Price or at the Issue Price. If the distributor acquires the Securities at the Issue Price, the Issuer may pay to the
distributor a distribution fee. Such fees received by the distributor may be in addition to the brokerage commissions/fees
normally applied by the distributor. The investor acknowledges and agrees that such fees are retained by the distributor. Further
information is available from the distributor upon investor's written request.
If applicable, the distributor may receive a portion of the management fee on a recurring basis (trailer fees) for efforts undertaken
by the distributor for placement/distribution of the Securities and other services rendered. The investor acknowledges and agrees
that such fees are retained by the distributor. Further information is available from the distributor upon investor's written request.
In receiving payments by third parties, the distributors interests may be adverse to those of the holders of this investment
product and such payments could therefore adversely affect the investors return on the investment product.
This document, and the information contained therein, does not constitute the provision of investment advice; its sole purpose is the
description of the Securities. Investing in these Securities entails risks and a decision to invest must in all cases be taken only based on the
Offering Circular. Please consider all risks described in the Offering Circular carefully prior to investing in the Securities and consult your
professional independent financial, legal, accounting, and/or tax adviser with respect to an investment in the Securities. For further
information, please contact your personal client advisor.
All opinions contained herein are based on the current view of Deutsche Bank AG, and may be amended without prior notice. Deutsche
Bank AG does not make any representation, recommendation or warranty, regarding the accuracy, adequacy, reasonableness or
completeness of the information contained herein, even though all information contained herein originates from reliable sources. All rates
and prices are subject to changes and are published for information purpose only and not as indicator for tradable rates and prices. Past
Performance is not indicative of future results.
The distribution of these Securities is prohibited in some jurisdictions. This document and the information contained herein may only be
distributed and published in jurisdictions in which such distribution and publication is permitted. In particular these Securities may not be
offered or sold in the United States, the UK, Canada, Japan, the European Economic Area or to US Persons.
Disclaimer for XETRA DAX
XETRA DAX
(the Index) is calculated and published by and the term XETRA DAX is protected as trade mark of Deutsche Brse AG.
The 100% Capital Protected Note on XETRA DAX
with 124% Cap is not in any way sponsored, sold or promoted by Deutsche Brse AG
(the "Owner"). The Owner makes no warranty or representation whatsoever, expressly or by implication, either as to the results to be
obtained from the use of the "Index" and/or the figures at which the said Index stands at any particular time on any particular day or
otherwise. The Owner shall not be liable (whether in negligence or otherwise) to any person for any error in the Index and shall not be
under any obligation to advise any person of any error therein.
MiFID: Further risk disclosures pursuant to MiFID can be obtained on http://globalmarkets.db.com/riskdisclosures
127
1
Shark Note linked to the Dow Jones EURO STOXX 50
with
100% capital protection, 150% Barrier and 6% Rebate
Final Termsheet
Product Description
This Shark Note (the Security) is a EUR denominated Security with a lifetime of 3 years. It is linked to the
performance of the Dow Jones EURO STOXX 50 Price Index
(the Underlying). The Security offers a full

participation to the performance of the DJ EURO STOXX 50 Index
up to the barrier level of 150%. If the

Undelying has never touched or exceeded the Barrier Level during the lifetime of the Security, the investor will
receive 100% of the Nominal Amount plus the positive Performance of the Underlying index, if any. If the
Barrier Level has been touched or exceeded, however, the redemption amount will be the Nominal Amount
plus a 6% Rebate Amount, paid at maturity.
This Security is capital protected at maturity only. During the lifetime of the Security, it may have a value
below par.
This Shark Note is a bond or cash alternative targeted at investors who want a capital protection while
enhancing their returns. Investors expectations should be slightly positive, expecting the Dow Jones EURO
STOXX 50 Index
not to trade above 150% of the Initial Reference Level during the investment period.
December 3, 2008
Issuer Deutsche Bank AG, Frankfurt (S&P: AA-, Moodys: Aa1)
Issue Volume Up to 5000000 (notional)
Nominal Amount EUR 1000 per Security
Issue Price 100% of the Nominal Amount
Name of the Underlying Initial Reference Level
Underlying
Dow Jones EURO STOXX 50 Price Index
ISIN: EU0009658145
RIC: .STOXX50E
2369.52
Capital Protection 100%
Upside Participation Factor 100%
Initial Valuation Date December 3, 2008
Payment Date December 10, 2008
Last Trading Day December 2, 2011
Final Valuation Date December 2, 2011
Settlement Date December 9, 2011
Index Dow Jones EURO STOXX 50 Price Index
Index Sponsor STOXX Limited

2
with
Final Termsheet
Settlement Cash
Initial Reference Level The official closing price of the Underlying on the Initial Valuation Date.
Final Reference Level The official closing price of the Underlying on the Final Valuation Date.
Barrier Level 150% of the Initial Reference Level (3554.28)
Barrier Event A Barrier Event is deemed to have occurred if during the Observation
Period, the relevant Underlying is equal to or higher than the Barrier Level.
The Barrier is observed continuously.
Observation Period From Initial Valuation Date (excluding) to and including Final Valuation
Date.
Rebate Amount 6% of Nominal Amount, i.e. EUR 60
Redemption at Maturity On Settlement Date the Security holder is entitled to receive the following
cash amount:
1. If the level of the Underlying has traded at or above the Barrier Level
at any time on any day during the Observation Period:
Nominal Amount + Rebate Amount
2. If the level of the Underlying has never traded at or above the
Barrier Level at any time on any day during the Observation Period:
Nominal Amount * [(100% + max (0%; Final Reference Level/ Initial
Reference Level-1)]
Minimum Subscription/
Trade Size
1 Security
Swiss Taxation No Swiss withholding tax on interest and premium payments. No Swiss
issue stamp duty. Swiss turnover stamp duty on secondary market
transactions of up to 0.30%.
This Security is classified as transparent, where the predominant part of
the annual yield of the bond component is in the form of a single interest
payment (IUP = Intrt Unique Predominant). For individuals having their
tax residence in Switzerland and holding the Security as part of their
private property the following applies:
Any increase in value of the bond component of the Security realized at
sale or settlement over the value of the bond component at issue or
purchase is subject to income tax pursuant to the so-called modified
differential taxation (Modifizierte Differenzbesteuerung). The present value
of the bond component at issue (bond floor) is EUR 913.81, the bond
component at settlement is EUR 86.19 (IRR 3.0500%).
Any other gains realized upon sale or settlement on the derivative
financial instrument component of the Security will be tax-exempt capital
gain for such investors.
128
3
with
Final Termsheet
The afore mentioned tax treatment is valid on the federal level at the time
of issue and is not exhaustive. The relevant tax laws and the
administrative practice are subject to change. Deutsche Bank AG
expressly excludes all liability in respect of any tax implications.
EU Savings Tax Treatment For Swiss paying agents, this Security is not in scope of the Swiss law
relating to EU savings tax (TK2).
Governing Law/Jurisdiction ENGLISH LAW/LONDON
Clearing Agent Clearstream, Euroclear
Calculation and Paying
Agent
The Calculation Agent shall have no responsibility for good faith errors or
omissions in respect of any calculations or determinations contemplated
herein, and its calculations and determinations shall, in the absence of
manifest error, be final, conclusive and binding on note holders and/or
Deutsche Bank AG.
Selling Restrictions United States, US Persons, the United Kingdom, European Economic
Area, Canada, Japan
Secondary Market The Issuer will under normal market conditions provide bid/offer prices
with a maximum spread of 1% on Reuters Page DEDB4QVF=DBBL.
SVSP Product Type 470 Capital protection with knock-out
ISIN DE000DB4QVF6
WKN DB4QVF
4
with
Final Termsheet
Disclaimer
Security Risks: The Securities are derivative financial instruments. An investment in the Securities entails risks similar to a direct
investment in the Underlying. Accordingly, the investor could suffer a loss of the entire capital invested if the Underlying becomes worthless.
Issuer Risk: The investors bear the credit risk of Deutsche Bank AG as Issuer of the Securities. The value of the Securities depends not
only on the Performance of the Underlying but also on the solvency of the Issuer, which may vary over the lifetime of the Securities. The
"Securities"). The complete terms and conditions are included in the Offering Circular. The facts contained herein are merely for information
purposes. This document, and the information contained therein, does not constitute an issue prospectus according to the articles 652a and
1156 of the Swiss Code of Obligations ("CO"). Only the terms and conditions included in the Offering Circular, which can be obtained free of
charge at Deutsche Bank AG, Zurich branch, X-markets, Postfach 3604, 8021 Zurich, are binding.
In connection with the offer and sale of the Securities, the distributor may acquire the Securities from the Issuer at a discount to
the Issue Price or at the Issue Price. If the distributor acquires the Securities at the Issue Price, the Issuer may pay to the
distributor a distribution fee. Such fees received by the distributor may be in addition to the brokerage commissions/fees
normally applied by the distributor. The investor acknowledges and agrees that such fees are retained by the distributor. Further
information is available from the distributor upon investor's written request.
If applicable, the distributor may receive a portion of the management fee on a recurring basis (trailer fees) for efforts undertaken
by the distributor for placement/distribution of the Securities and other services rendered. The investor acknowledges and agrees
that such fees are retained by the distributor. Further information is available from the distributor upon investor's written request.
In receiving payments by third parties, the distributors interests may be adverse to those of the holders of this investment
product and such payments could therefore adversely affect the investors return on the investment product.
Performance is not indicative of future results.
offered or sold in the United States, the UK, Canada, Japan, the European Economic Area or to US Persons.
Disclaimer for Dow Jones EURO STOXX 50 Price Index
The Dow Jones EURO STOXX 50 Price Index
is the intellectual property (including registered trademarks) of STOXX Limited, Zurich,

Switzerland and/or Dow Jones & Company, Inc. a Delaware corporation, New York, USA, (the "Licensors"), which is used under license.
The securities based on the Index are in no way sponsored, endorsed, sold or promoted by the Licensors and neither of the Licensors shall
have any liability with respect thereto.
129
Protected
Local Cap
Terms and conditions
Date: 16 October 2007
Main characteristics Investment profile
3 years Maturity
Performance
GBP (Quanto) Currency
Basket of indices Underlying
Risks
100,00% guaranteed at maturity Capital
100,00% of the rise of each index of
the basket until 155,00%
Participation
Rating criteria detailed in the enclosed appendix
"Performance-Risk profile"
Economic comments
x The KOSPI 200 index is an index of 200 Korean stocks which make up 90% of the total
market value of the Korea Stock exchange.
x The Russian depositary index (EUR) is comprised of the most liquid depository receipts on
Russian shares that are traded on the London Stock exchange.
x The Hang Seng China Enterprises Index (HSCEI) is an index comprised of H-shares listed
on the Hong Kong Stock exchange and included in the Hang Seng Mainland Composite
Index.
x The MSCI Taiwan index represents stocks listed on the Taiwan Stock Exchange
x The Ishares MSCI Brazil Index Fund is an ETF with objective to provide a performance
which corresponds to the evolution of publicly traded securities in the Brazilian market.
Protected
Local Cap
Description
Anticipated scenario

Increase of the basket of indices
Advantages
PRIV/SPS - Structured Products Solutions - 2 / 6
The Protected Local Cap allows the investor to benefit from 100,00% of
the rise of each index i of the basket until a Cap of 155,00% at maturity

A high potential return is offered

The capital is 100,00% guaranteed at maturity
Drawbacks

The redemption at maturity can be lower than the redemption of a
monetary deposit on the same period

The capital is guaranteed only at maturity

The profit can not exceed 55,00% at maturity
Mechanism

The product offers 100,00% of the rise of each index i of the basket
capped to 55,00% while guaranteeing 100,00% of the capital at maturity
130
Protected
Local Cap
Description
Payoff at maturity

Example 1: The Underlying performance is positive

If the Underlying finishes 18% above the initial level then the investor will receive
118,00% of the invested amount.
If the Underlying finishes more than 55,00% above its initial level, the
redemption will be capped to 155,00% of the invested amount.

Example 2: The performance of the Underlying is negative

If the Underlying finishes 20% below the initial level then the investor receives
100,00% of the invested amount.

Protected
Local Cap
Issuer J.P. Morgan International Derivatives Ltd, London
Guarantor JPMorgan Chase Bank (AA/Aaa)
Type Euro Medium Term Note (EMTN)
Currency GBP (No currency risk)
Nominal GBP 1 180 000 / 1 180 Notes
Denomination GBP 1 000 per Note
Minimum Trading Amount GBP 1 000 / 1 Note
Launch Date 16
th
October 2007
Initial Observation Date 23
rd
October 2007
Issue Date 30
th
October 2007
Final Observation Date 22
nd
October 2010
Maturity Date 29
th
October 2010
Issue Price 100,00% of the Denomination
Underlying The equally weighted basket composed of the following
indices :
Index (i) Reuters Page Strike Price Weight
1 - KOSPI 200 Index
2 - Hang Seng China Enterprise Index
3 - Ishares MSCI Brazil
4 - MSCI Taiwan Index
5 - Russian Depositary Index
KOSPI2 Index
HSCEI Index
EWZ Index
TWY Index
RDX Index
To be determ.
To be determ.
To be determ.
To be determ.
To be determ.
20%
20%
20%
20%
20%
Strike Price Closing price of the Underlying on Initial Observation
Date
Guarantee 100,00% at maturity
Participation 100,00% of the rise
Cap 155,00%
Underlying Level
u
5
1
; ) ( ) (
i
i
initial
Index
i
t
Index
Cap Min i Weight t Underlying
Where Index
i
t
: the closing price of the index (i) on Observation
Date (t).
Index
i
initial
: the closing price of the index (i) on Initial
Observation Date
131
Protected
Local Cap
Redemption at maturity If on Final Observation Date the Underlying closes
above or equal to the Strike Price, the investor will
receive :
u u 1 100 on Denominati
Initial
Underlying
Final
Underlying
ion Participat %
Paid on Maturity Date
If on Final Observation Date the Underlying closes
strictly below the Strike Price, the investor will receive :
Denomination x 100,00%
Paid on the Maturity Date
Cash Delivery At maturity, the settlement of the Note will be made in
cash.
Calculation Agent JPM
Listing This Note will not be listed.
Secondary market Under normal market conditions a daily Bid/Offer price
will be quoted on the secondary market with a 1,00%
spread.
If the requested trading size is too large in view of the
liquidity of the Underlying asset or volatility abnormally
high, the relevant calculation agent keeps the
possibility, at its discretion, to widen the Bid/Offer
spread.
The Bid/Ask Price of the Product includes the accrued
interest that the Investor is entitled to received (Dirty
Price)
ISIN Code To be determined
Selling conditions This issue does not constitute a public offer of securities
and will not be subject to the clearance procedures of
the competent authorities.
Payment / Delivery Clearstream / Euroclear
Warning Investors bear the issuer risk. The investment
instrument's value is dependent not only on the
development of the underlying, but also on the
creditworthiness of the issuer, which may vary over the
term of the structured product.
Protected
Local Cap
"SG Private Banking draws your attention that investment in this product implies certain financial risks notably
liquidity risks, currency risks, volatility risks... and SG Private Banking recommends you to consult your own legal,
tax, financial, accounting and other professional advisors in order to ensure that this transaction is suitable for your
situation and explain the consequences that may arise from the investment in this product.
Moreover, SG Private Banking indicates that the Guarantor of this Structured Product has a credit rating and a credit
spread that might change over time, this affecting the secondary market price. Also the investor should be aware
that the redemption at maturity of such Structured Product is subject to the non occurence of any credit event or
event of default affecting the Guarantor during the life of the Structured Product."
Risks factors
Disclaimer
"This product is destined to prospective investors who possess sufficient knowledge, based on their own experience,
to evaluate the advantages and the risks inherent to the product. Socit Gnrale and its subsidiaries strongly
advise prospective investors to consider, based on the risks inherent to the product and based on their own
judgement or on the recommendations of their professional advisor they have chosen to consult, the suitability of the
product as an investment in the light of their own circumstances and financial condition and represent that you have
consulted with your financial, tax and legal advisors prior to execution of any transaction. Socit Gnrale and its
subsidiaries do not provide tax, legal and accounting advice. You should conduct a thorough and independant
review of the legal, tax and accounting aspects of any information provided to you or any transaction which you may
enter into in light of your particular circumstances. The information contained herein are indicative only and can be
subject to change with market fluctuations. Socit Gnrale and its subsidiaries have used their best endeavours
to present the information fairly and accurately but make no representations and provide no warranties to that effect
or to its reliability. This product may be submitted to a specific taxation in consideration where it is sold. In the event
where the product is not traded on the secondary market, SG Private Banking may issue a new similar product in
the market terms and conditions applicable at that moment. Socit Gnrale and its subsidiaries are under no
circumstances to be considered as responsible for the financial, legal or tax consequences of the product, nor its
performances, even in the case that market information have been communicated by themselves."
132
Pricing Supplement No. 5 to the Prospectus Dated December 21, 2005 and the
Prospectus Supplement dated December 21, 2005
US$3,500,000
Royal Bank of Canada
Senior Global Medium-Term Notes, Series B
Principal Protected Notes due August 28, 2009
(Linked to the Dow Jones Industrial Average
SM
)
Issuer: Royal Bank of Canada (Royal Bank)
Issue Date: February 28, 2006
Maturity Date and
Term: August 28, 2009 (resulting in a term to maturity of three-and-one-half years)
Coupon: We will not pay you interest during the term of the Notes.
Underlying Index: The return on the Notes is linked to the performance of the Dow Jones Industrial
Average
SM
(the Index).
Minimum Investment: US$5,000 (Subject to such other restrictions, as may be applicable to such investors under
the private offering rules of any jurisdiction outside the United States. See Risk
FactorsNon-U.S. Investors May Be Subject to Certain Additional Risks.)
Denomination: US$1,000 and integral multiples thereof.
Payment at Maturity: At maturity, you will receive a cash payment equal to the principal amount invested plus
an amount equal to that principal amount multiplied by greater of:
(1) 0%, or
(2) the percentage change.
Percentage Change: The percentage change is equal to the following (expressed as a percentage):
Average Index Level Initial Index Level
Initial Index Level
Initial Index Level: 11,069.22, the closing level of the Index on February 23, 2006 (the initial valuation
date).
Average Index Level: As determined on the nal valuation date, the average index level will be the arithmetic
average of the closing levels of the Index on the annual observation dates.
Annual Observation
Dates:
August 23, 2006, August 23, 2007, August 25, 2008, and August 25, 2009.
August 25, 2009 is also the nal valuation date for determination of the average index
level.
Clearance and
Settlement:
DTC global (including through its indirect participants Euroclear and Clearstream,
Luxembourg as described under Ownership and Book-Entry Issuance in the
accompanying prospectus).
CUSIP Number: 78008EAQ0
Listing: The Notes will not be listed on any securities exchange or quotation system.
Calculation Agent: JPMorgan Chase Bank, N.A.
Investing in the Notes involves risks that are described in the Risk Factors section beginning on page P-4 of this pricing
supplement and page S-4 of the accompanying prospectus supplement.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these
Notes or passed upon the accuracy of this pricing supplement or the accompanying prospectus and prospectus supplement.
Any representation to the contrary is a criminal offense.
We may use this pricing supplement in the initial sale of Notes. In addition, RBC Capital Markets Corporation or another of
our afliates may use this pricing supplement in market-making transactions in any Notes after their initial sale. Unless we or
our agent informs you otherwise in the conrmation of sale, this pricing supplement is being used in a market-making transaction.
The Notes will not constitute deposits insured under the Canada Deposit Insurance Corporation or by the United States
Federal Deposit Insurance Corporation or any other Canadian or United States governmental agency or instrumentality.
Price to Public Agents Commission
Proceeds to
Royal Bank of Canada
Per Note . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100% 3.25% 96.75%
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,500,000 $113,750 $3,386,250
RBC Capital Markets Corporation
Pricing Supplement dated February 23, 2006
133
Call us on 0800 032 4600
Visit www.abbey.com
Call in to any Abbey branch
Savings and Investments Information
Guaranteed Growth Plan (Issue 27) Stockmarket Option
Term Sheet 5 years
Provided by Abbey National PEP & ISA Managers Limited (ANPIM)
Product Features
Term 5 years
Guaranteed minimum return at maturity 11%
Maximum return at maturity
50% of the
growth in the
FTSE 100 Index
up to a maximum
of 40%
Key Dates
What I will get back
At the end of the term, this plan guarantees you a minimum
return of 11% after 5 years. Your final return at maturity will
be the greater of your initial investment plus either:
11% after 5 years, or
50% of the FTSE 100 Index growth, up to a maximum of 40%.
We calculate your return as follows:
The starting level of the FTSE 100 Index will be taken as the
closing level on the commencement date.
The final level is the average of the daily closing levels of the
FTSE 100 Index over the last six months of the investment.
By using an average at the end of the investment term the
performance of the FTSE 100 Index is smoothed from sudden
fluctuations shortly before maturity. Whilst this could reduce
the benefits of a rising market, it also reduces the adverse
effects of a falling market.
Examples
The table illustrates what you might get back at maturity, based
on an initial investment of 10,000.
Your initial
capital
Index
growth
Percentage
return
Your return
(including
capital)
10,000 100% 40% 14,000
10,000 80% 40% 14,000
10,000 60% 30% 13,000
10,000 5% 11% 11,100
10,000 5% 11% 11,100
Please remember there is no guarantee that the FTSE 100 Index
will rise or behave the way it has done in the past.
Available from 16 November 2009. Closing date 5 January 2010 or earlier if sold out.
This Term Sheet forms part of the Key Features and should also be read along with the Terms and Conditions
Event Date
Start of offer period 16 November 2009
End of offer period
5 January 2010 or
earlier if sold out
Last date for receiving ISA transfers
from current provider
22 December 2009
Commencement date 20 January 2010
Averaging period
19 January 2015
16 July 2015
Maturity date 20 July 2015
Savings and Investments Information
Why should I invest early?
Start of
offer period:
16 November
2009
End of
offer period:
5 January
2010
Commencement
date:
20 January
2010
Share price
0.9991
Share price
0.9998
Share price
1.0000
The illustration above shows the share prices available at the
beginning and end of the offer period. The share price rises by
a constant amount throughout this period. The advantage of
applying early is that you will get a lower share price, which
means that you receive more shares than if you applied later in
the offer period. The return on your investment is based on the
number of shares you hold.
For example, an application for 7,200 received on 16 November
2009, will get 7,206.49 shares, based on a share price of 0.9991.
An application of 7,200 received on 5 January 2010 will get
7,201.44 shares, based on the higher share price of 0.9998.
The reason for offering a rising share price during the offer
period is to compensate for the interest that would have been
received, if your money had remained in an ordinary savings
account earning interest. The rate of interest that we use in
determining the rising share prices is equivalent to 0.5% AER
(see note 1).
How much will the advice/sale cost?
Our sales costs are already included in the plan and wont
affect the return you may get.
If you pay a lump sum of 7,200 into the plan ANPIM would
pay Abbey National plc 328.64.
Abbey National PEP & ISA Managers Limited is making the
offer in association with the Investment Company, Guaranteed
Investment Products 1 PCC Limited. Protected cells (Protected
Cell 127 for ISAs and Protected Cell 128 for Direct Share
Investment Plans) have been set up in the Investment Company
and aim to give you the returns described in this Term Sheet
and the Key Features. There are also other share funds in the
Investment Company.
LIFE 0530 NOV 09 TI
Note 1: AER stands for Annual Equivalent Rate and shows what the interest rate would be if we paid interest and added it to your account each year.
This product is provided by Abbey National PEP & ISA Managers Limited, which is a wholly owned subsidiary of Santander Asset Management UK Holdings Limited. Registered in Scotland
No.151605 at: 287 St Vincent Street, Glasgow G2 5NB, United Kingdom. Telephone 0845 6000 181. Authorised and regulated by the Financial Services Authority.
FSA registration number 171448. You can check our authorisation with the Financial Services Authority at www.fsa.gov.uk/register or by calling them on 0845 606 1234.
As of 11 January 2010, Abbey National plc will change its name to Santander UK plc.
Abbey National plc, Registered Office: 2 Triton Square, Regents Place, London NW1 3AN, United Kingdom. Registered number 2294747. Registered in England. www.abbey.com
Telephone 0870 607 6000. Calls may be recorded or monitored. Authorised and regulated by the Financial Services Authority except in respect of its consumer credit products for which
Abbey National plc is licensed and regulated by the Office of Fair Trading. FSA registration number 106054. Abbey and the flame logo are registered trademarks.
Abbey National plc advises on mortgages, a limited range of life assurance, pension and collective investment scheme products and acts as an insurance intermediary for general insurance.
This item can be recycled. 134
SUMMARY
You Get You Get
What You
Nick Motson
39
Pay For!
HOMEWORK THIS WEEK
Compulsory
Study the 2 attached term sheets:
i) 3 Year Twin Win Note
ii) 1 Year Protected Scoop
Draw the payoff diagrams and try to determine the component parts
involved in structuring the products.
There are 2 possible ways to structure the Scoop, I will provide a bottle of
wine as a prize if anybody can come up with both ways.
O ti l
Nick Motson
40
Optional
How to Invest in Structured Products A Guide for Investors and Asset
Managers by Andreas Blumke
Pages 1-43
135
"This product is destined to prospective investors who possess sufficient knowledge, based on their own experience, to evaluate the advantages and the risks inherent to the
product. Socit Gnrale and its subsidiaries strongly advise prospective investors to consider, based on the risks inherent to the product and based on their own judgement or
on the recommendations of their professional advisor they have chosen to consult, the suitability of the product as an investment in the light of their own circumstances and
financial condition.
Socit Gnrale and its subsidiaries are under no circumstances to be considered as responsible for the financial, legal or tax consequences of the product, nor its performances,
even in the case that market information have been communicated by themselves."
Safety
Dynamic
Speculative
Non Capital Guaranteed
3Y GBP Twin Win Note
FTSE 100 Index
TERMS AND CONDITIONS
x MECHANISM:
Benefit from the following Payoff at Maturity:
i 1
st
Case: The Underlying has never reached (continuously monitored) the barrier fixed at 60%
of its initial level.
The holder is redeemed at 100% of its nominal plus
100% of the absolute performance of the Index if the performance of the Index is negative
110% of the performance of the Index if the performance of the Index is positive
Example: We assume a strike of the Underlying at 100 %.
Level of the Underlying Redemption at Maturity
61% 139%
80% 120%
100% 100%
110% 111%
120% 122%
i 2
nd
Case: The underlying has reached (continuously monitored) at least once the barrier
fixed at 60% of its initial level at any time during the whole life of the product. The holder
receives:
i its initial nominal reduced by the decrease of the Index if the Index finishes below
its initial level
i Its initial nominal plus 110% of the positive performance of the Index if the Index
finishes above its initial level
Example: We assume a strike of the underlying at 100 %.
Level of the Underlying Redemption at Maturity
40% 40%
50% 50%
70% 70%
100% 100%
120% 122%
x Key points :
- Benefit from the absolute negative performance if the barrier has never been reached (continuously monitored)
- Benefit from 110% of the performance if the index rises at maturity
- The capital is only at risk in the case of a strong drop of the Underlying (-40%).
x WARNING:
- The investor is well aware that the product is built with the purchase of trackers and the sale of options. It can
in no way be considered a capital guaranteed product. The bonus is conditional and cannot be considered as
guaranteed either.
Safety
Dynamic
Speculative
3Y GBP Twin Win Note
FTSE 100 Index
Issuer J.P. Morgan International Derivatives Ltd.
Guarantor JPMorgan Chase Bank, National Association (AA2, AA-)
Type Certificate
Currency GBP
Nominal GBP 5,000,000 (5 000 certificates)
Denomination GBP 1,000
Minimum investment 50 certificates per investor
Launch date 05
th
December 2006
Initial Observation Date 05
th
December 2006
Issue date 04
th
January 2007
Final Observation Date 07
th
December 2009
Maturity date 04
th
January 2010
Strike price 6 086.40 (Closing Price of the underlying on Initial Observation Date)
Issue price 100% of the nominal
Underlying FTSE 100 Index < Bloomberg Code: UKX Index >
Down Barrier 3 651.84 (60% of the strike price)
Redemption Amount
At maturity, the holder of the note will receive the following amount:
If on Final Observation Date, the closing price of the Underlying is strictly below
its strike price AND
1) The Underlying has never reached (continuously monitored) the Down Barrier
between the Initial Observation Date and the Final Observation Date (included), the
holder of the note will receive:
u u 1 % 100 1 on Denominati
initial
final
Index
Index
ABS
paid at maturity
(Cash delivery)
2) The Underlying has reached (continuously monitored) at least once the Down
Barrier between the Initial Observation Date and the Final Observation Date, the
holder of the note will receive:
u
initial
final
Index
Index
on Denominati
paid at maturity (Cash delivery)
If on Final Observation Date, the closing price of the underlying is equal or above
its Strike price
u 1 x % 110 1 on Denominati
initial
final
Index
Index
paid at maturity (Cash delivery)
136
Where Index
initial
: the closing price of the Underlying on Initial Observation Date
Index
final
: the closing price of the Underlying on Final Observation Date
Selling Conditions This issue does not constitute a public offer of securities and will not be subject to the
clearance procedures of the competent authorities.
Secondary market Under normal market conditions a daily Bid/Offer price will be quoted on the
secondary market with a 1% spread.
If the requested trading size is too large in view of the liquidity of the underlying asset
or volatility abnormally high, the relevant calculation agent keeps the possibility, at its
discretion, to widen the Bid/Offer spread.
Listing None
ISIN Code Coming
Settlement Clearstream / Euroclear
"This product is destined to prospective investors who possess sufficient knowledge, based on their own experience, to evaluate the
advantages and the risks inherent to the product. Socit Gnrale and its subsidiaries strongly advise prospective investors to consider, based
on the risks inherent to the product and based on their own judgement or on the recommendations of their professional advisor they have
chosen to consult, the suitability of the product as an investment in the light of their own circumstances and financial condition.
Socit Gnrale and its subsidiaries are under no circumstances to be considered as responsible for the financial, legal or tax consequences of
the product, nor its performances, even in the case that market information have been communicated by themselves."

EU savings tax
(Swiss ruling)
OUT OF SCOPE
Telekurs code
2
Internal code
307
Disclaimer This product does not represent a share in an investment fund and is
not subject to the supervision of the Swiss Federal Banking
Commission. Investors are therefore not eligible for the specific
protection under the Swiss Federal Law on Investment Funds. The
terms and conditions for this product does not qualify as prospectus
and has not been registered with any regulatory authority.
This document is for your information purposes only and is not
intended as an offer, or a solicitation of an offer, to buy or sell any
specific product and should not be treated as giving investment
advice. Structured transactions are complex and may involve a high
risk of loss. Prior to entering into a transaction, you should consult
with your own legal, tax, financial and accounting advisors to the
extent you consider it necessary, and make your own investment
decision (including decision regarding the suitability of this type of
transaction) based upon your own judgement since SGPB is not
acting as your financial advisor or fiduciary. The terms of any
investment will be subject to the detailed provisions, including risk
considerations, contained in the issuer documentation.
Selling restrictions: Offers and sales of the notes are subject to
restrictions in some jurisdictions. The Notes may not be sold or
offered within the United States or to U.S.persons.
Tax issues: Persons considering the purchase of notes are urged to
consult their tax advisers with regard to the application of tax laws
to their particulars situations as well as any tax consequences arising
under the laws of any state, local or foreign taxing jurisdiction.
Socit Gnrale and its subsidiaries strongly advise prospective
investors to consider, based on the risks inherent to the product and
based on their own judgement or on the recommendations of their
professional advisor they have chosen to consult, the suitability of
the product as an investment in the light of their own circumstances
and financial condition.
The information contained herein are indicative only and can be
subject to change with market fluctuations. Socit Gnrale and its
subsidiaries have used their best endeavours to present the
information fairly and accurately but make no representations and
provide no warranties to that effect or to its reliability.
Socit Gnrale and its subsidiaries are under no circumstances to
be considered as responsible for the financial, legal or tax
consequences of the product, nor its performances, even in the case
that market information have been communicated...
137
1-Year GBP Protected Scoop
Underlying Investment FTSE 100 Index
Capital Guaranteed Structured Products
May 2008
Capital Guaranteed Structured Products are designed for investors who wish to preserve the potential for
higher-than-cash returns but in a risk-controlled environment. In other words, they allow you to maintain
exposure to markets but with the peace of mind of knowing that your capital is protected if the investment is
held to maturity.
Your capital is placed with a bank (the issuer), which invests on your behalf in a specific market. The bank
places on deposit the portion of the capital, which if held to maturity, guarantees the full repayment of the
capital. The banks derivatives traders invest the remainder in options strategies in a variety of markets. At
maturity you get back your initial capital plus the outcome of the options strategies.
Many variables dictate how a capital guaranteed product is priced, principally interest rates, volatility of the
underlying index, basket of stocks, or currency as well as the maturity date of the product. Maturity terms
will vary according to pricing of the product in the market. However you should be aware that at maturity the
option may expire worthless, therefore you may not receive a return on your investment.
Capital guaranteed structured products can be issued either as fixed-term deposits or as Euro Medium
Term Notes or Certificates. The different issuing methods have their benefits for investors but the issuing
structure has no bearing on the pricing of the product.
The capital guarantee is effective only when the product is held to maturity. Early redemption may
result in the return of less capital than was originally invested.
Key Features
Advantages A conditional bonus of 14% if the FTSE 100 Index trades strictly within a
predefined range during the reference period.
100% capital guarantee at maturity.
Risks If FTSE 100 Index trades out of the range no conditional bonus will be
applied.
In the case of a significant decrease or increase in the value of the
underlying, the value of the EMTN on the secondary market will approach the
net present value of the guaranteed capital at maturity.
The return at maturity can be lower than the return of a monetary deposit
over the same period.
Target Market Clients seeking returns in excess of current money market deposit rates, with
a medium appetite for risk.
We offer the following one-year strategy in GBP whereby the capital is 100% guaranteed at maturity. The
investor benefits from a conditional bonus of 14% if FTSE 100 remains strictly within a predefined range
during the reference period.
Issuer & Guarantor To Be Determined (Minimum AA- /Aa3)
Type EMTN/EMTC
Currency GBP
Nominal Minimum GBP 1,000,000
Underlying FTSE 100 Index
Secondary Market Minimum GBP 50,000
Launch Date To Be Determined
Value Date To Be Determined
Final Observation Date Launch Date + 1 Year
Maturity Date Value Date + 1 Year
Strike To Be Determined on Launch Date
Range 75%-115% of the Strike
Reference Period From Launch Date to Final Observation Date
Bonus at Maturity The bonus is equal to 14% if the underlying stays strictly in the
range during the reference period, otherwise
The bonus is equal to 0%
Business Day London
Selling Conditions This issue does not constitute a public offer of securities and has not been
subject to the clearance procedures of the competent authorities.
Secondary Market Under normal market conditions a daily Bid/Offer price will be quoted on the
secondary market with a 1% spread.
If the requested trading size is too large in view of the liquidity of the
underlying asset or volatility abnormally high, the relevant calculation agent
reserves the right, at its discretion, to widen the Bid/Offer spread.
ISIN Code To Be Determined
100% Capital Guaranteed
1-Year GBP Protected Scoop
Indexed on FTSE 100 Index
INDICATIVE TERMS & CONDITIONS
Ri sk
138
Warning The redemption at maturity can be lower than the redemption of a monetary
deposit on the same period.
During the life of the product, its price may drop below 100%.
The marked to market may not fluctuate in the same proportion as the
underlying: its price depends on a combination of forwards, volatility, interest
rates, time to maturity etc... Indeed, to benefit fully from the stability of the
underlying, the investor needs to carry the product to maturity.
Moreover, SG Hambros indicates that the Guarantor of this Structured
Product has a credit rating and a credit spread that might change over time,
this affecting the secondary market price. Also the investor should be aware
that the redemption at maturity of such Structured Product is subject to the
non occurrence of any credit event or event of default affecting the Guarantor
during the life of the Structured Product.
Exit Fees SG Hambros reserves the right to charge an exit fee of 1% for early
redemption.
Payment/Delivery Clearstream / Euroclear
100% Capital Guaranteed Products
100% capital guaranteed products do exactly what the name implies; they guarantee the return at maturity of the initial
capital invested, in addition to a variable bonus payment which is dependent on the performance of an underlying. A
guaranteed minimum bonus payment may be applied under certain circumstances.
100% capital guaranteed products are generally purchased by investors who are looking to limit the loss of capital whilst
participating in volatile markets. As such, investors are willing to forgo the potential of a higher return which can be
achieved by accessing the market directly in exchange for the guaranteed return of capital at maturity.
These products generically have the following characteristics:
A 100% capital guarantee at maturity regardless of the performance of the underlying
Predefined index, interest rate, currency or basket of shares as the underlying
A bonus will be paid according to the movements of the underlying
A guaranteed yield may be paid over the life of the product or at maturity (dependent on pricing)
If the underlying under-performs, then at maturity the investors will receive their initial capital back in full plus any
guaranteed bonus if applicable
Short investment term
Risk Warnings
The following product has been selected for your consideration. You should note that 100% Capital Guaranteed
Structured Products will only guarantee the return of the initial capital at maturity. The guarantor of the product is yet to be
determined (AA-/Aa3). Your investment in this product is at risk in the event of a default by the guarantor. Early withdrawal
or redemption may return less than was originally invested. The repayment structure selected and the performance of the
chosen underlying assets will determine the bonus payment and in some cases this may be zero due to market conditions.
The redemption at maturity can be lower than the redemption of a monetary deposit for the same period. An increase in
the level of interest rates will have an adverse impact on the mark-to-market value of the note. In the case of a significant
decrease in the value of the underlying, the value of the note will approach the net present value of the guaranteed capital
at maturity.
The minimum size on the secondary market is GBP 50,000.
The terms of the product may allow for the issuer to pay a fee to the Structured Products Services of SG Private Banking.
This fee is then paid by intra-company transfer to the entity dealing with the client. The amount of this will depend on
market conditions, but is not expected to exceed 1% of Principal for each year of the products term. The fee will be paid at
trade date, and is not refundable in the event of early redemption or sale on the secondary market. Secondary market
transactions may be subject to dealing or commission charges or a bid/offer spread. Further details will be available from
your Private Banker.
139
Lecture 5
Equity Structured Products II
Not only can you not turn a toad into a prince by kissing it but you cant
Nick Motson
1
Not only can you not turn a toad into a prince by kissing it..but you cant
turn a toad into a prince by repacking it
Warren Buffet.
140
INTRODUCTION
Last week we covered equity growth products
By now you should be familiar with
What the component parts are What the component parts are
Zero Coupon Bond
Option/Options, Vanilla/Exotic
What Factors Affect Pricing
Primary Market
Secondary Market
Nick Motson
2
This week we will cover yield products and
some more exotic equity products
YIELD / REVENUE PRODUCTS
Use of options paying a pre-defined
performance if a pre-announced scenario performance if a pre-announced scenario
materialises to enhance the yield:
Could be the purchase of binary (digital) or
barrier options
Alternatively it could be the sale of options
Nick Motson
3
y p
The 2 approaches obviously have different risks
141
REVERSE CONVERTIBLE NOTES
The most common yield products are Barrier Reverse
Convertible Notes (sometimes called Reverse
Exchangeable)
The Basic Structure is as follows:
You receive a guaranteed coupon whatever happens which is
substantially higher than the market rate
If the underlying asset is above the current level at maturity
you get all of your capital back
If the underlying asset is below the current level at maturity but
has never fallen more than the barrier you get all of your
Nick Motson
4
y g y
capital back
If the underlying asset is below the current level in at maturity
and has fallen more than the barrier at any point, your capital is
reduced by the amount of the fall
Underlying
Asset Rises
Underlying
Asset Falls
PAYOFF SCENARIOS
Asset Rises
Asset Falls
Never Fallen
Below Barrier
Barrier
Touched
Nick Motson
5
High
Coupon +
100% of
Capital
High
Coupon +
100% of
Capital
High
Coupon +
Reduced
Capital
142
EXAMPLE 1
COUPON: 8.6%
MATURITY: 1-YEAR
STRIKE PRICE:$57.40
Nick Motson
6
BARRIER: $39.606
143
USD 1,000,000 8.6% Reverse Exchangeable Securities into
McDonalds Corp with 69% Knock-in due 26 June 2009
05 June 2008
FINAL TERMS AND CONDITIONS
Issuer : ABN AMRO Bank N.V. (incorporated in The Netherlands with its statutory seat in Amsterdam)
(Senior Long Term Debt Rating: Moody's Aa2, S&P AA-)
Underlying : McDonalds Corp
Underlying RIC : MCD.N
Underlying Bloomberg : MCD US
Underlying Currency : USD
Exchange : New York Stock Exchange
Issue Price : 100%
Strike Price : USD 57.4
Exchange Price : Equal to 100% of the Strike Price
Knock-in Price : USD 39.606 (69% of Strike Price)
Final Reference Price : The price of the Underlying quoted on the Exchange at the Valuation Time on the Valuation
Date(s)
Exchange Amount : 17.422 (Number of Underlying equal to Denomination divided by the Exchange Price)
If the Exchange Amount is an amount comprising a fraction of any Underlying shares, the
Holder will receive an Exchange Amount comprising of the nearest whole number (rounded
down) of Underlying shares (taking into account that a Holder's entire holding may be
aggregated at the Issuer's discretion for the purpose of delivering the Exchange Amount), and
an amount in the Settlement Currency equal to the value of the outstanding undelivered
fraction of such Underlying share, as calculated by the Calculation Agent on the basis of the
Final Reference Price converted into the Settlement Currency at the prevailing FX Rate (if a
FX Rate is applicable).
Coupon : 8.6% Actual/360, payable in arrear on 26 June 2009
Coupon Breakdown : Interest Rate Component: 3.545%, Option Part Component: 5.055%
Pricing : Clean Price
Number Issued : 1,000
Denomination : USD 1,000
Nominal Amount : USD 1,000,000
Valuation Date : 19 June 2009
Valuation Time : The official close of trading on the Exchange.
Maturity Date : 26 June 2009
Knock-in Event : means that the price of the Underlying on the Exchange trades at or below the Knock-in Price
at any time during the Observation Period
Observation Period : From and including the Pricing Date to and including the Valuation Date
Settlement : Cash or Physical Settlement determined by Redemption/Settlement Amount
Settlement Currency : USD
FX Rate : Not Applicable
Settlement Amount : (a) If a Knock-in Event has not occurred, each Security will be redeemed at an amount
equivalent to Par.
(b) If a Knock-in Event has occurred, each Security will be redeemed at the sole discretion of
the Issuer either:
(i) at an amount equivalent to Par; or
(ii) By delivery of the Exchange Amount
Business Day : London and Clearing Agent's
Traded Markets
Page 1 of 4
Trading Day : Any day that is a trading day on the Exchange or on an options or futures exchange or
quotation system on which options contracts or futures contracts or other derivatives contracts
on the Underlying are traded ("Related Exchange") other than a day on which trading on the
Exchange or Related Exchange is scheduled to close prior to its regular weekday closing time
Listing : SWX Swiss Exchange
Clearing : SIS (SEGA Intersettle), Clearstream Banking S.A, Euroclear Bank S.A.
Security Codes : ISIN Code: CH0042167277, Valoren Code: 4216727, Symbol Code: RCMCL
Form : Dematerialised
CH Classification for EU Savings
Directive :
Category 6
Public Offering Countries : Switzerland (CH)
Calculation Agent : ABN AMRO Bank N.V., London Branch
Secondary Market : ABN AMRO Bank N.V. intends (but is not obliged) to maintain a secondary market throughout
the life of the product with a maximum spread of 1% on a daily basis (subject to normal market
conditions)
Selling Restrictions : Please refer to Appendix A hereto
Governing Law : English
Time Table
Subscription Period : From 06 June 2008 up to and including 13 June 2008, which may be extended at the sole and
absolute discretion of the Issuer
Pricing Date : 20 June 2008
Launch Date : 06 June 2008
Issue Payment Date : 27 June 2008
Listing Date : 27 June 2008
Public Offer Date : 27 June 2008
This term sheet is for information purposes only and does not constitute an offer to sell or a solicitation to buy any security or other financial instrument.
Traded Markets
Page 2 of 4
144
Appendix A
Disclaimer
This term sheet is for information purposes only and does not constitute an offer to sell or a solicitation to buy any security or other financial instrument.
All prices are indicative and dependent upon market conditions and the terms are liable to change and completion in the final documentation.
WARNING: The contents of this document have not been reviewed by any regulatory authority in the countries in which it is distributed. Investors are
advised to exercise caution in relation to the contents of this document. If you are in doubt, you should obtain independent professional advice.
Due to its proprietary nature, this proposal is confidential. This material is intended solely for the use of the intended recipient(s) and the contents may not
be reproduced, redistributed, or copied in whole or in part for any purpose without the express authority of ABN AMRO.
Any purchase of the Securities should be made on the understanding that the purchaser shall be deemed to acknowledge, represent, warrant and undertake
to ABN AMRO that (i) it consents to the provision by ABN AMRO to any governmental or regulatory authority of any information regarding it and its dealings
in the Securities as required under applicable regulations and/or as requested by any governmental or regulatory authority; and (ii) it agrees to promptly
provide to ABN AMRO, or directly to the relevant governmental or regulatory authority (and confirm to ABN AMRO when you have done so), such additional
information that ABN AMRO deems necessary or appropriate in order for ABN AMRO to comply with any such regulations and/or requests.
From time to time the Issuer may enter into and receive the benefit of generic commission, discount and rebate arrangements from hedge providers and
other transaction counterparties, and reserves the right to retain any such amounts received without any obligation to pass the benefit of the rebates to
investors in the Securities.
The Issuer may exercise its absolute discretion not to issue the Securities if it deems there is insufficient interest in the Securities or if market conditions
deteriorate prior to the Issue Date. If the Issuer decides not to issue the Securities, all subscription monies received will be refunded (net of all applicable
charges and without interest) as soon as practicable. Investors who subscribe for Securities from or through intermediaries will need to rely on such
intermediaries to credit the return of the relevant refund.
The information set out in this document is a summary of some of the key features of the Securities. This summary should be read in conjunction with, and
is qualified in its entirety by reference to the Conditions of the Securities which are available on request.
This Investment Product is issued by ABN AMRO Bank N.V., London Branch, which holds the only legally binding terms (including risk and legal
considerations) and which is available upon request.
The terms and conditions set out in this document are, prior to the Issue Date, indicative. No assurance can be given that such an issue could in fact be
arranged and that no specific issuer is obligated to issue such Securities or obligations. This document is neither a simplified prospectus as stated in Art.
5 Collective Investment Law ("CISA") nor a prospectus in accordance with Art. 652a / Art. 1156 Swiss Code of obligation. This product is not an investment
fund and therefore not subject to supervision by the Swiss Federal Banking Commission. As a consequence, the investor does not benefit from the specific
investor protection provided under the Collective Investment law ("CISA"). Investors in the Securities are exposed to the credit risk of the issuer.
Selling Restrictions
General
No action has been taken or will be taken by the Issuer that would permit a public offering of the Securities or possession or distribution of any offering
material in relation to the Securities in any jurisdiction where action for that purpose is required. No offers, sales or deliveries of any Securities, or distribution
of any offering material relating to the Securities, may be made in or from any jurisdiction except in circumstances that would result in compliance with any
applicable laws and regulations and would not impose any obligation on the Issuer.
These Securities may not be offered or sold (i) to any person/entity listed on sanctions lists of the European Union, United States or any other applicable
local competent authority; (ii) within the territory of Cuba, Sudan, Iran and Myanmar; (iii) to residents in Cuba, Sudan, Iran or Myanmar; or (iv) to Cuban
Nationals, wherever located.
US, Netherlands and UK. The Securities may not be offered or sold within the United States or the Netherlands or, to or for the benefit of, US persons,
Dutch persons or private customers in the United Kingdom.
Risk Factors
Investment in the Securities involves significant risks and while the following summary of certain of these risks should be carefully evaluated before making
an investment in the Securities, the following does not intend to describe all possible risks of such an investment:
(a) Investment risks
The price of the Securities may fall in value as rapidly as it may rise and investors may not get back the amount invested. The price of the Securities may
be affected by a number of factors, including changes in the value and volatility of the underlying asset(s), the creditworthiness of the Issuer, changes in
foreign exchange rates and economic, financial and political events that are difficult to predict. The past performance of an underlying asset or other security
or derivative should not be taken as an indication of the future performance of that underlying asset or other security or derivative during the term of the
Securities. Owning the Securities is not the same as owning the underlying asset(s) and changes in the market value of any underlying asset may not
necessarily result in a comparable change in the market value of the Securities.
(b) Reverse Exchangeables
Reverse Exchangeable securities are bond style products, paying a coupon, which, at maturity, can be redeemed either at par or by delivery of a
predetermined number of the underlying asset(s) (or cash equivalent) at the issuer's discretion. Investors are therefore at risk that the value of the
predetermined number of underlying asset(s) at maturity may be less than the par value of the securities, and in an extreme case, could be worth zero.
Accordingly, this investment bears the market risk of a direct equity investment. Investors should be aware that the more the price of the underlying asset(s)
decreases, the more likely it is that the underlying asset(s) will be delivered.
(c) Suitability of the Securities
The purchase of the Securities involves certain risks including market risk, credit risk and liquidity risk. Investors should ensure that they understand the
nature of all these risks before making a decision to invest in the Securities. Investors should carefully consider whether the Securities are suitable for them
in light of their experience, objectives, financial position and other relevant circumstances. If in any doubt, investors should obtain relevant and specific
professional advice before making any investment decision. In structuring, issuing and selling the Securities, ABN AMRO is not acting in any form of
fiduciary or advisory capacity.
(d) Creditworthiness of Issuer
The Securities constitute general unsecured contractual obligations of the Issuer and of no other person. Investors in the Securities are relying upon the
creditworthiness of the Issuer and have no rights under the Securities against any other person, including the issuer of any underlying asset or, where the
Securities relate to an index, the sponsor of the index.
Traded Markets
Page 3 of 4
(e) Secondary market trading
No assurance can be given that any trading market for the Securities will exist or whether any such market will be liquid or illiquid. While the Issuer expects
to make a market in the Securities, it is not obliged to do so. Any market making activity if commenced may be discontinued at any time. If the Securities
are not traded on any exchange, pricing information may be more difficult to obtain and the liquidity and price of the Securities may be adversely affected.
(f) Conflicts of interest
ABN AMRO and its officers and employees may from time to time (i) have long or short positions in the Securities, the underlying asset(s) or other Securities
or derivatives that may affect the value of the Securities; and/or (ii) possess or acquire material information about the Securities, the underlying asset(s)
or other Securities or derivatives that may affect the value of the Securities. ABN AMRO may at any time solicit or provide investment banking, commercial
banking, credit, advisory or other services to the issuer of any underlying asset. Such activities and information may cause consequences that are adverse
to the interests of the investors in the Securities or otherwise create various potential and actual conflicts of interest. ABN AMRO has no obligation to
disclose such activities or information or other potential and actual conflicts of interest and may engage in any such activities without regard to the interests
of the investors in the Securities or the effect that such activities may directly or indirectly have on any Note.
(g) Hedging activities
Notwithstanding any communication that you may have had with ABN AMRO in respect of the manner in which ABN AMRO may establish, maintain, adjust
or unwind its hedge positions with respect to the Securities, (i) ABN AMRO may in its absolute discretion determine when, how or in what manner it may
establish, maintain or adjust or unwind its hedge positions; (ii) ABN AMRO may, but is not obliged to, hedge the Securities dynamically by holding a
corresponding position in the underlying asset(s) or any other Securities, derivatives or otherwise and may hedge the Securities individually or on a portfolio
basis; and (iii) any hedge positions are the proprietary trading positions of ABN AMRO and are not held on your behalf or as your agent.
(h) Early termination
The Issuer may terminate the Securities if it determines that it has become unlawful for the Issuer to perform its obligations under the Securities or its ability
to source a hedge or unwind an existing hedge in respect of the Securities is adversely affected in any material respect. If the Issuer terminates early the
Securities, the Issuer will, if and to the extent permitted by applicable law, pay a holder of the Securities an amount determined to be its fair market value
immediately before such termination notwithstanding such circumstances less the actual cost to the Issuer of unwinding any underlying related hedging
arrangements.
(i) Adjustments
The Issuer may make adjustments to the terms of the Securities if an event which affects an underlying asset requires it. This may include any event which
has or may have a concentrating or diluting effect on the theoretical value of any underlying asset, including, without limitation, any cash dividend or other
cash distribution, stock dividend, bonus issue, rights issue, or extraordinary dividends, or the insolvency of the issuer of the Underlying, nationalisation of
the assets of the issuer of the Underlying and delisting or suspension of the Underlying.
(j) Market disruption
The Calculation Agent for the Securities may determine that a market disruption event has occurred or exists at a relevant time. Any such determination
may affect the value of the Securities and/or delay settlement in respect of the Securities. A Market Disruption Event includes any suspension or limitation
of trading on the Exchange or any Related Exchange, the declaration of a general moratorium in respect of banking activities in the country where the
Exchange or any Related Exchange is located and the inability of ABN AMRO to unwind its hedge or related trading position relating to the Underlying due
to illiquidity. Upon the occurrence of Market Disruption Event, the determination of the closing price of the Underlying will be made on the first succeeding
exchange business day on which there is no Market Disruption Event whereas such Market Disruption Event has continued for five consecutive exchange
business days after the original determination date such fifth exchange business day is deemed to be the Valuation Date and the Calculation agent shall
determine the good faith estimate of the value for the Underlying on such exchange business day. The final settlement date (or the settlement date in
respect of an early termination or redemption date) will be delayed accordingly.
(k) Emerging markets
If applicable, Investing in emerging markets involves certain risks and special considerations not typically associated with investing in other more established
economies or Securities markets. Such risks may include (i) the risk of nationalization or expropriation of assets or confiscatory taxation; (ii) social, economic
and political uncertainty; (iii) dependence on exports and the corresponding importance of international trade and commodities prices; (iv) less liquidity of
Securities markets; (v) currency exchange rate fluctuations; (vi) potentially higher rates of inflation (including hyper-inflation); (vii) controls on investment
and limitations on repatriation of invested capital; (viii) a higher degree of governmental involvement in and control over the economies; (ix) government
decisions to discontinue support for economic reform programs and imposition of centrally planned economies; (x) differences in auditing and financial
reporting standards which may result in the unavailability of material information about economics and issuers; (xi) less extensive regulatory oversight of
Securities markets; (xii) longer settlement periods for Securities transactions; (xiii) less stringent laws regarding the fiduciary duties of officers and directors
and protection of investors; and (xiv) certain consequences regarding the maintenance of portfolio Securities and cash with sub-custodians and Securities
depositories in emerging market countries.
(l) FX market disruption
Investors should note that all payments on expiry or a secondary market purchase by the Issuer are subject to the ability of the Issuer to (i) sell the underlying
asset(s); (ii) convert the currency of an underlying asset into the currency of the Securities; and (iii) transfer the currency of the Securities from accounts
in the country where an underlying asset is located to accounts outside that country. The occurrence of any of these events may affect the value of the
Securities and and/or delay settlement in respect of the Securities or, if such events result in settlement being delayed for the period specified in the terms
and conditions for the Securities, may result in all obligations of the Issuer in respect of the Securities being extinguished.
Traded Markets
Page 4 of 4
145
EXAMPLE 1
Reverse Exchangeable McDonalds Corp
8.6% Coupon with 69% Knock-in
190
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
R
e
d
e
m
p
t
i
o
n

P
r
o
c
e
e
d
s
Nick Motson
7
0
10
20
30
0 10 20 30 40 50 60 70 80 90 100
Share Price
Barrier Not Touched Barri er Touched Buy Underl yi ng
EXAMPLE 2
COUPON: 11.25%
Nick Motson
8
MATURITY: 1-YEAR
STRIKE PRICE: 88.36
BARRIER: 66.27
146

Documents for the Warrant and Certificate Programme of the Issuer. The Offering Documents will be made available upon the issuance of the Securities.
X Yield Enhancement
11.25% p.a. Barrier Reverse Convertible on
Deutsche Bank
Final Terms and Conditions as of 29P
th
P November 2007
Description of the Product
The Barrier Reverse Convertible is a product that offers the investor a Coupon which is higher than the Coupon of a
comparable standard bond. In return for this, the Investor takes the risk that he will receive the Underlying Share (or
an equivalent cash amount) at the Final Settlement Date. This will be the case if the Underlying Share closes at or
below the Strike Level on the Valuation Date and the Barrier Level has been touched during the Observation Period. In
this scenario, the Settlement Amount will be less than 100% of the Nominal. As long as the Underlying Share has not
touched its Barrier Level, the Final Settlement Amount will always be 100% of the Nominal.

General Terms:
Issuer Merrill Lynch International & Co. C.V. with registered offices at Kaya W.F.G
Mensing 36, Curaao, Netherland Antilles
Guarantor Merrill Lynch & Co. Inc., Wilmington, Delaware 19801, USA
(Long term senior unsecured debt rating: S&P A+, Moodys A1, Fitch A+)
Arranger Merrill Lynch International
Dealer Merrill Lynch International
Calculation Agent Merrill Lynch International, 2 King Edward Street, London
Principal Security Agent JPMorgan Chase Bank N.A., London Branch
Security Codes ISIN: XS0334830741 Valor: 3222021

Timetable:
Trade Date 29 November 2007
Issue Date 13 December 2007
Valuation Date 28 November 2008 (the Exercise Date)
Final Settlement Date 12 December 2008
Specific Terms:
Name Bloomberg Reuters Exchange Underlying Share
Deutsche Bank DBK GY DBKGn.DE Xetra
Currency EUR
Issue Price 100%
Aggregate Principal Amount EUR 3.000,000
Nominal Amount EUR 1,000 per Security (=Denomination)
Ratio 1 Security entitles to one times the Settlement Amount on the Final Settlement
Date
Coupon 11.25% p.a., paid semi-annually
Payment per EUR 1,000 will be EUR 56.25 on the Coupon Payment Dates
For Swiss tax purposes, the payment is split into two components:
4.69% p.a. interest payment subject to income tax
6.56% p.a. option premium which is classified as capital receipt
Coupon Payment Dates 12 June 2008 and 12 December 2008
Reference Share Price EUR 88.36
Strike Price EUR 88.36 (set at 100% of the Reference Share Price on Trade Date)

Barrier Level EUR 66.27 (will be set at 75% of the Reference Share Price on Trade Date)
Number of Shares per
Denomination
11.3173 (=Denomination divided by Strike Price)
Barrier Event Means an event as determined by the Calculation Agent where the Underlying
Share has traded at or below the Barrier Level during the Observation Period
(continuous observations)
Settlement Amount on the Final
Settlement Date
1. If a Barrier Event has NOT occurred:
Then the investor will receive 100% of the Nominal Amount in cash
2. If a Barrier Event has occurred:
Then if
x On the Valuation Date the Underlying Share closes above its Strike Price,
the investor will receive 100% of the Nominal Amount in cash
x On the Valuation Date the Underlying Share closes at or below its Strike
Price, the investor will receive the number of Shares per Denomination.
Fractional entitlements will be paid in cash, based on the Underlying
Shares closing price on the Valuation Date
For the avoidance of doubt, the Coupons will be paid in either case
Observation Period Any Exchange Business Day during the period from the Trade Date to and
including the Valuation Date

Secondary Market Merrill Lynch International will make a secondary market on a best efforts basis
with a bid-ask spread no larger than 1% under normal market conditions (clean
prices)
Place of Jurisdiction English Courts
Listing None
Clearing Euroclear and Clearstream
Settlement Method Cash or Physical
Automatic Exercise Applicable
Minimum Exercise Amount 1 Security
Business Days London and Frankfurt
Form of Securities Bearer
TEFRA D Not applicable
Minimum Investment Amount 1 Security
Day Count 30 / 360

Quotes / Information:
Internet HTwww.mlinvest.ml.comTH
Source of Information This simplified prospectus can be obtained free of charge at Merrill Lynch Capital
Markets AG, Zurich, Switzerland
Reuters XS033483074=MERL

Risk for investors:
Product-specific risks
The securities described herein are derivative financial instruments. The potential
loss of an investment in those securities is similar to a direct investment in the
Underlying, i.e. could result in a total loss of the invested capital. The upside
147

potential is limited and will not exceed the Nominal Amount and Coupon payment.
During the term of the investment, the bid offer spread might be wider than 1%,
depending on market conditions
Issuer risk The investment instruments value is dependent not only on the development of
the underlying, but also on the creditworthiness of the issuer, which may vary over
the term of the structured product

Tax Provisions:
Swiss Federal Stamp Duty Secondary market transactions are not subject to Swiss stamp duty. If shares are
delivered to the investor at redemption, the delivery of the shares is in principle
subject to Swiss stamp duty
Swiss Federal Income Tax For private investors with tax domicile in Switzerland, the interest part of the
payment is subject to Swiss federal as well as cantonal and communal income tax;
the premium part of the payment is classified as capital gain
Swiss Withholding Tax This security is not subject to the Swiss withholding tax
EU Savings Tax Directive For Swiss paying agents, the interest part of the payment is subject to the EU
savings tax (TK6)

Supervision:
Merrill Lynch Capital Markets
AG
Is a Swiss licensed bank, a securities dealer and a member of the Swiss
Exchange and Virt-X. As a Swiss Bank it is regulated by the Swiss Federal
Banking Commission
Merrill Lynch International Is Authorised and Regulated by the Financial Services Authority. Member of the
London Stock Exchange
Merrill Lynch International & Co.
C.V. (MLICO)
Is a Netherlands Antilles limited partnership of unlimited duration which
commenced operation on 1P
st
P August, 1975 under registered number 11705 in the
Commercial Registry of the Chamber of Commerce in Curaao. MLICO complies
with the Netherlands Antilles corporate governance regime. MLICO is not a
regulated or supervised entity

Important Information for Swiss Investors:
The Securities are qualified as structured products, not as collective investment schemes in terms of the Swiss Federal Act on Collective Investment
Schemes (CISA), and the Securities are neither subject to the approval nor to the supervision of the Swiss Federal Banking Commission.
The Securities constitute direct, unsubordinated, unconditional and unsecured obligations of MLICO C.V and will rank equally with MLICO C.V.'s
other direct, unsubordinated, unconditional and unsecured contractual obligations. However the Securities are subject to an unconditional and
irrevocable guarantee from Merrill Lynch & Co. Inc. (ML&CO)
The insolvency of the ML&CO may lead to a partly or total loss of the invested capital.
The Securities are not issued or guaranteed by a bank.
The proceeds of these Securities will be used for general corporate purposes.

Sales Restrictions:
United States. The Securities will not be registered for public sale in any jurisdiction and so will be available only in accordance with applicable,
available, private offering rules. The security described herein is not for sale in the U.S. or to U.S. persons and this communication may not be
distributed in the U.S.
No Prospectus (as defined in the EU Prospectus Directive 2003/71/EC (Prospectus Directive)) will be prepared in connection with the Securities.
Accordingly, the Securities may not be offered to the public in any European Economic Area (EEA) member state and any purchaser of the
Securities who subsequently sells any of their Securities in any EEA member state must do so only in accordance with the requirements of the
Prospectus Directive as implemented in that member state.

Re-Distribution:
In connection with the offer and sale of the Securities, the distributor will acquire the Securities from the Lead Manager at a discount to the issue
price or at the issue price. If the distributor acquires the Securities at the issue price, the Lead Manager will pay to the distributor a distribution fee.

Such amounts received by the distributor may be in addition to the brokerage cost/fee normally applied by the distributor. The purchaser
acknowledges that such distribution fee may be retained by the distributor. Further information is available from the distributor on request.

Disclaimers:
This communication does not contain a complete description of the Securities and the risks associated with an investment therein, and are subject
to and qualified in their entirety by reference to the Offering Documents.
This Term Sheet contains indicative terms only. All materials contained herein are for discussion purposes only. Finalised terms and conditions are
subject to further discussion and negotiation. We make no representation and have given you no advice concerning the appropriate accounting
treatment or possible tax consequences of this indicative transaction.
This communication is furnished at the request of the recipient for the exclusive purpose of identifying the nature of the security or other instrument
referred to herein. It is furnished for your private information with the express understanding, which the recipient acknowledges, that it does not
constitute an offer of such security or a means by which such security may be offered or sold. The terms outlined herein are indicative only and are
subject to change. While we consider the information herein reliable, we do not represent that it is accurate or complete and it should not be relied
upon as such. Any written offer of such security may be made only by means of the Offering Documents or similar document and any related
supplements thereto. The security referred to herein may involve a high degree of risk, which may include principal, interest rate, index, currency,
credit, political, liquidity, time value, commodity and market risk and is not suitable for all investors. We or our affiliates may buy or sell securities or
have long or short positions in securities economically related to any security mentioned herein. We or our affiliates may have an investment
banking or other commercial relationship with the issuer of any security mentioned herein.
Merrill Lynch International will not be responsible for the consequences of reliance upon any statement or information contained herein or any
omission herefrom. We make no representation and have given you no advice concerning the appropriate accounting treatment or possible tax
consequences of this indicative transaction. Investors should consult their own investment, tax and other professional advisors before investing in
the Securities.
The Securities have not been registered for public sale in any jurisdiction and are therefore available only in accordance with applicable private
offering rules. This means that the Securities may not be available in all jurisdictions or may be available to a limited number of qualifying investors
only. This indicative term sheet is intended for your personal use and you must not give it or show it to any other person.
Notice for UK Investors: The Issuer does not have a place of business in the United Kingdom and is not regulated by the UK Financial Services
Authority. As a consequence, the regulatory regime governing your rights as an investor in respect of the Issuer (and its similarly unauthorised,
overseas agents and affiliates) will be different to that of the United Kingdom. The UK rules for the protection of private investors and the UK
Financial Compensation Scheme will not apply in respect of such entities, although if your securities account is serviced from the UK by Merrill
Lynch International Bank Limited, the normal UK protections will apply in relation to the services that it provides. Approved for issue in the UK by
Merrill Lynch, Pierce, Fenner & Smith Limited, Merrill Lynch Financial Centre, 2 King Edward Street, London EC1A 1HQ.
148
EXAMPLE 2
Reverse Convertible DeutscheBank
11.25% Coupon with 75% Knock-in
220
230
240
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
190
200
210
220
R
e
d
e
m
p
t
i
o
n

P
r
o
c
e
e
d
s
Nick Motson
9
0
10
20
30
40
0 20 40 60 80 100 120 140 160 180 200
Share Price
Barrier Not Touched Barrier Touched Buy Underlying
STRUCTURI NG
How do we produce the yield?
A coupon paying bond or a deposit (just use p p y g p (j
market rate)
How do we enhance the yield?
Collect option premium (sell options, what
type?)
Nick Motson
10
What is the risk?
149
STRUCTURI NG
REVERSE CONVERTIBLE
COUPON PAYING BOND
=
+
Nick Motson
11
SHORT
PUT OPTION
(vanilla or barrier)
+
EXAMPLE 1
Nick Motson
12
150
EXAMPLE 2
Nick Motson
13
EXAMPLE 2
Investors in the Merrill Note on Deutsche Bank
Nick Motson
14
Investors in the Merrill Note on Deutsche Bank
- Received their 11.25% coupon
- Lost 68% of their Capital
NOW YOU KNOW THE RISK!
151
STRUCTURI NG
What type of stocks will this work for?
Ones that have recently bombed
Big fall leads to increased implied volatility
(remember the smile)
Selling Down & In Put is Short Vega
Also helps convince people ..it cant go any further
Nick Motson
15
STRUCTURING DOWN & IN PUT
SELLING A
VANILLA
PUT PUT
WOULD
YIELD
9.30%
Nick Motson
16
152
STRUCTURING DOWN & IN PUT
SELLING A
DOWN & IN
PUT YIELDS PUT YIELDS
6.83%
ALTHOUGH
2.5% LOWER
THAN THE
VANILLA IT
OFFERS THE
Nick Motson
17
DOWNSIDE
PROTECTION
TO 75%
EXTREMELY POPULAR
Nick Motson
18
153
BONUS CERTIFICATE
EXAMPLE
Nick Motson
19
154
^
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:
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:
1
8
.
0
5
.
2
0
0
Pncij
Pni1icivn1icN
BcNU- Cii1ircn1i cN Svn1cn
UNLii.iNc: Svn1cn (Bccviic: UHR SW)
BcNU-Livi:iio
Bniiiii Livi: ; (ccN1iNUcU- cv-iivn1icN)
^n1Uii1.: ij ^cN1n-
Si11iiN1 CUiiiNc.: CHI
155
Pncij
Svn1cn
^nixi1Lxvic1n1icN-
Ihe inve:lcr i: |ccking lc prcfl frcm c :icewcy: lrenc cf lhe Uncer|ying. Ihey cc ncl
exc|uce lhe pc::iLi|ily cf mccercle|y fc||ing price:, Lul wcu|c |ike lc pcrlicipcle in
pc:ilive mcve: cf lhe Uncer|ying un|imilec|y.
RiccciNLn1icN
lnve:ling in c 8cnu: Cerlifccle cffer: lhe inve:lcr c relurn even in :icewcy: lrencing
cr :|ighl|y fc||ing price: cf lhe Uncer|ying. Wherec: lhe pcrlicipclicn in pc:ilive Uncer-
|ying mcve: i: un|imilec, lhe inve:lcr i: :ecurec cgcin:l c negclive ceve|cpmenl cf
lhe Uncer|ying ccwn lc lhe 8crrier Leve|.
Di-ciiv1icN
/ 8cnu: Cerlifccle wilh c 8cnu: Leve| cf 110 pcy: lhe inve:lcr c minimum cf 110
cf lhe l::ue Frice c: |cng c: lhe 8crrier Leve| cf 74 i: ncl lcuchec cr :urpc::ec curing
lhe prccucl: |ifelime. Shcu|c lhe Uncer|ying ri:e cLcve lhe 8cnu: Leve| lhe inve:lcr
pcrlicipcle: in lhi: mcvemenl incefnile|y. Shcu|c lhe Uncer|ying lcuch lhe 8crrier
Leve| curing lhe prccucl |ifelime lhe inve:lcr wi|| receive c precefnec numLer cf lhe
Uncer|ying cn lhe Fecemplicn Dcle.
Ihe Swclch Grcup i: in lhe Lu:ine:: cf mcnufccluring cnc :e||ing: wclche:, jewe||ery,
c|cck: cnc wclch ccmpcnenl:. Ihe Grcup mcnufcclure: cn crrcy cf ccmpcnenl:
Lclh fcr lheir 1 inlernc| Lrcnc: c: we|| c: fcr lhirc pcrly mcnufcclurer: in Swilzer|cnc
cnc ccrc:: lhe g|cLe. ln cccilicn lc lhi: lhe Grcup mcinlcin: c |eccing rc|e in lhe
mcnufcclure cnc :c|e cf e|eclrcnic :y:lem: fncing u:e Lclh in lhe wclch incu:lry
c: we|| c: in clher Lrcnche:. Ihe Grcup emp|cy: mcre lhcn 24,000 pecp|e in cver 50
ccunlrie:. ln 2008, lurncver wc: 5,Ln Swi:: frcnc: {2007: 5,41), nel prcfl 838m Swi::
frcnc: {2007: 1,015).
ln lhe ccnlexl cf lhe |crge :hcre price ccrreclicn: cf pc:l mcnlh: lhe :hcre: cf lhe
wclch ccmpcny hcve :ufferec grecl|y, lhu: prcvicing cn cppcrlune lime lc enler
lhe lrccilicnc| Swi:: ncme. Ihe mcncgemenl i: expecling mccercle grcwlh in 200
Lc:ec cn :c|ic :c|e: fgure: in Frcnce, llc|y, Grecl 8rilcin, Germcny cnc Mc|cy:ic c:
we|| c: lhe impcrlcnl grcwlh mcrkel: cf Fu::ic, Chinc cnc Ec:lern Eurcpe.
Given lhcl lhe ccmpcny cim: cl increc:ing mcrkel :hcre lhey wi|| neilher Le recu-
cing lheir mcrkeling Lucgel ncr per:cnne| expencilure:. Mcre |ike|y lhey wi|| Le |cc-
king lc cchieve :cving: in lhe crec: cf lrcn:pcrl cnc ccmmccilie:.
Hi:lcric perfcrmcnce in lhe |c:l 24 mcnlh::
Lxvic1n1icN-. RiccciNLn1icN. Di-ciiv1icN.
Swotch
Scurce: 8|ccmLerg
Fc:l perfcrmcnce i: ncl incicclive cf fulure perfcrmcnce.
0
10
20
30
40
50
0
70
80
10.04.2007 10.07.2007 10.10.2007 10.01.2008 10.04.2008 10.07.2008 10.10.2008 10.01.200 10.04.200
Pni1icivn1icN
Pn.crr Picri
Pnci;
Ihe lnve:lcr i: enlil|ec lc receive frcm lhe l::uer cn lhe Fecemplicn Dcle per Frccucl:
SciNniic i
lf c 8crrier Evenl hc: NCI cccurrec cnc
c. lf lhe Finc| Fixing Leve| i: cl cr Le|cw lhe lnilic| Fixing Leve| mu|lip|iec
wilh lhe 8cnu: Leve| {in ), lhe lnve:lcr wi|| receive c Cc:h Sell|emenl
in lhe Sell|emenl Currency ccccrcing lc lhe fc||cwing fcrmu|c:
Issue Fr|ce 8onus Ieve| [|n %}
L. lf lhe Finc| Fixing Leve| i: cLcve lhe lnilic| Fixing Leve| mu|lip|iec wilh
lhe 8cnu: Leve| {in ), lhe lnve:lcr wi|| receive c Cc:h Sell|emenl in
lhe Sell|emenl Currency ccccrcing lc lhe fc||cwing fcrmu|c:
Issue Fr|ce F|no| F|x|ng Ieve| J In|t|o| F|x|ng Ieve|
SciNniic z
lf c 8crrier Evenl H/S cccurrec, lhe lnve:lcr wi|| receive c precefnec rcunc numLer
{i.e. Ccnver:icn Fclic) cf lhe Uncer|ying per Frccucl. /ny pclenlic| frcclicnc| Ccn-
ver:icn Fclic enlil|emenl: {Frcclicn cf Uncer|ying:), wi|| Le pcic in cc:h Lc:ec cn lhe
Finc| Fixing Leve|.
8orr|er Event
/ 8crrier Evenl :hc|| Le ceemec lc cccur if cl cny lime cn cny Exchcnge 8u:ine:: Dcy
curing lhe 8crrier CL:ervclicn Fericc lhe |eve| cf lhe Uncer|ying': Lic price hc: Leen
uclec cnc/cr lrccec cl cr Le|cw lhe 8crrier Leve|, c: rec:cncL|y celerminec Ly lhe
Cc|cu|clicn /genl.
RiLiv1icN SciNniic-
Pni1icivn1icN
Frcfil
0
8cnu:Leve|
Finc|FixingLeve|
U
n
c
e
r
|y
in
g
8crrierLeve|
Frccucl
NC8crrierEvenl
Frccucl
8crrierEvenl
156
Pnci
Ovvci1UNi1ii- s Ri-x-
Ovvci1UNi1ii- cr n BcNU- Cii1ircn1i
Un|imilec pcrlicipclicn in up:ice mcvemenl: cf lhe Uncer|ying.
/n cllrcclive yie|c cppcrlunily in :icewcy: lrencing cr :|ighl|y fc||ing price: cf
lhe Uncer|ying.
Ccncilicnc| ccpilc| prcleclicn ccwn lc lhe 8crrier Leve|. /: |cng c: lhe 8crrier Leve|
i: ncl lcuchec cr :urpc::ec lhe inve:lcr receive: lhe Lcnu: pcymenl cl recemp-
licn.
Liuic :eccnccry mcrkel cn lhe SlX Swi:: Exchcnge.
Ri-x- cr n BcNU- Cii1ircn1i
Shcu|c lhe Uncer|ying lcuch cr :urpc:: lhe 8crrier Leve| curing lhe |ifelime
cf lhe 8cnu: Cerlifccle, lhe |c:: pclenlic| cf lhe cerlifccle i: euc| lc lhcl
cf c cirecl inve:lmenl in lhe Uncer|ying.
F|ucluclicn: in lhe price cf lhe Frccucl ccn Le |crger lhcn fucluclicn: in lhe
price cf lhe Uncer|ying.
Ihe inve:lcr fcrgce: civicenc pcymenl: cn lhe Uncer|ying.
Depencing cn lhe inve:lcr: cepc:ilcry Lcnk, lrcn:cclicn fee: mcy Le |eviec fcr
lhe ce|ivery cf lhe Uncer|ying lc lhe inve:lcr: cepc:il.
Pni1icivn1icN
Pnciij
PicLUc1 INrcin1icN
PicLUc1Di1ni-
Uncer|ying Ihe Swclch Grcup /G-FEG {UHFN SW)
Swi:: Securily NumLer 1005711
lSlN CH01005711
SlX SymLc| EFGHW
l::ue Frice* CHF I8/
l::ue Size 1'000'000 Cerlifccle{:) {ccn Le increc:ec cl cny lime)
Sell|emenl Currency CHF
Dn1i-
SuL:criplicn Enc Dcle 18.05.200 1.00 CEI
F|ec:e ncle lhcl lhe SuL:criplicn Fericc mighl Le c|c:ec
ecr|ier.
lnilic| Fixing Dcle 18.05.200 {cr lhe ccy when lhe SuL:criplicn Fericc enc:)
l::ue Dcle 25.05.200
Fir:l Exchcnge Irccing Dcle 25.05.200 {cnlicipclec)
Lc:l Irccing Dcy/Iime 18.0.2010 / Exchcnge mcrkel c|c:e
Finc| Fixing Dcle 18/0/2010 {:uLjecl lc Mcrkel Di:ruplicn Evenl prcvi:icn:)
Fecemplicn Dcle 25/0/2010 {:uLjecl lc Sell|emenl Di:ruplicn Evenl
prcvi:icn:)
GiNiin INrcin1icN
l::uer EFG Fincncic| Frccucl: {Guern:ey) Llc., Sl Feler-Fcrl,
Guern:ey
Gucrcnlcr EFG lnlernclicnc| /G, Zurich, Swilzer|cnc
{Fcling: Filch / wilh :lcL|e cul|cck, Mcccy: /2 wilh
:lcL|e cul|cck)
Lecc Mcncger EFG Fincncic| Frccucl: /G, Zurich, Swilzer|cnc
Mcrkeling Fcrlner Migrc: 8cnk
Cc|cu|clicn /genl EFG Fincncic| Frccucl: /G, Zurich, Swilzer|cnc
Fcying /genl EFG Fincncic| Frccucl: /G, Zurich, Swilzer|cnc
Li:ling/Exchcnge SlX Swi:: Exchcnge: lrccec cn Scccch Schweiz /G
Li:ling wi|| Le cpp|iec fcr.
Seccnccry Mcrkel Dci|y price incicclicn: wi|| Le cvci|cL|e frcm
0:15 - 17:15 CEI cn www.efgfp.ccm, Ihcm:cn Feuler: |lSlN]
cnc 8|ccmLerg |lSlN] Ccrp cr cn EFGZ.
CuclclicnIype Seccnccrymcrkel price: cre uclec in lhe Sell|emenl
Currency, per Frccucl.
Sell|emenl Iype Cc:h Sell|emenl cr De|ivery cf Uncer|ying
Minimum lnve:lmenl 1 Cerlifccle{:)
Minimum Irccing Lcl 1 Cerlifccle{:)
Se||ing Fe:lriclicn: US/, US per:cn:, UK, EE/
C|ecring SlX SlS /G, Eurcc|ecr, C|ecr:lrecm
Depc:ilcry SlX SlS /G
Fcrm Uncerlifcclec Securily / 8cck-enlry
Gcverning Lcw/Juri:ciclicn Swi::/Zurich
* wi|| Le celerminec cn lhe lnilic| Fixing Dcle

Pni1icivn1icN
157
Pniij
Svi-- IiLiin S1nv
DU1.
Fcr Swi:: :lcmp culy purpc:e, lhe Frccucl i: lreclec
c: cnc|cgcu: lc c Lcnc. Iherefcre, :eccnccry mcrkel
lrcn:cclicn: cre, in princip|e, :uLjecl lc Swi:: :lcmp culy
{IK22). Ihe pc::iL|e De|ivery cf lhe Uncer|ying mcy Le
:uLjecl lc Swi:: :lcmp culy.
Svi-- IiLiin
INcci 1nx
Fcr lcx purpc:e: lhi: Frccucl i: c|c::ifec c: lrcn:pcrenl,
where lhe mcjcrily cf lhe relurn cf lhe Lcnc pcrl i: in lhe
fcrm cf c ci:ccunl cr cf cne pcymenl cn lhe Fecempli-
cn Dcle {lUF). Iherefcre, fcr privcle lnve:lcr: wilh lcx cc-
mici|e in Swilzer|cnc hc|cing lhe Frccucl c: pcrl cf lheir
privcle prcperly, lhe increc:e cf lhe vc|ue cf lhe Lcnc
pcrl {ccccrcing lc lhe Mccifzierle DifferenzLe:leue-
rung") cl :c|e cr cl recemplicn i: :uLjecl lc lhe Fecerc|
Direcl Icx. Ihe pre:enl vc|ue cf lhe Lcnc pcrl cl i::ue i:
lhe 8cncfccr per unil. /n lnve:lcr whc Luy: lhe Frccucl
cl i::ucnce cnc hc|c: il unli| Fecemplicn i: lcxec cn lhe
cifference Lelween lhe 8cncfccr cl lhe l::ue Dcle cnc
lhe 8cncfccr cl lhe Fecemplicn Dcle.
Hcwever, cny gcin cerivec frcm lhe cplicn i: ccn:icerec
c: ccpilc| gcin cnc i: lherefcre fcr :uch lcxpcyer: ncl
:uLjecl lc lhe Fecerc| Direcl Icx.
Ihe lcx lreclmenl regcrcing lhe ccnlcnc| cnc ccm-
munc| inccme lcxe: ccn ciffer frcm lhe lcx lreclmenl
regcrcing lhe Fecerc| Direcl Icx. 8ul in generc| lhe in-
ccme lcx lreclmenl: cre ccrre:pcncing.
Svi-- Wi1nncLiNc
1nx
Ihe Frccucl i: ncl :uLjecl lc lhe Swi:: wilhhc|cing lcx.
LU SnviNc- 1nx
Fcr Swi:: pcying cgenl:, lhe Frccucl i: ncl :uLjecl lc lhe
EU Scving: lcx {IK7).
Ihe lcx infcrmclicn cn|y prcvice: c generc| cverview cf lhe pclenlic| lcx ccn:euence:
|inkec lc lhi: Frccucl cl lhe lime cf i::ue. Icx |cw: cnc lcx ccclrine mcy chcnge cl cny
lime, pc::iL|y wilh relrccclive effecl.
lnve:lcr: cnc prc:peclive lnve:lcr: cre ccvi:ec lc ccn:u|l wilh lheir lcx ccvi:er: wilh
re:pecl lc lhe Swi:: lcx ccn:euence: cf lhe purchc:e, cwner:hip, ci:pc:ilicn, |cp:e cr
exerci:e cr recemplicn cf c Frccucl in |ighl cf lheir pcrlicu|cr circum:lcnce:. Ihe l::uer,
lhe Gucrcnlcr cnc lhe Lecc Mcncger hereLy expre::|y exc|uce cny |icLi|ily in re:pecl
cf cny pc::iL|e lcx imp|icclicn:.
1nxi-
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158
BONUS CERTIFICATE
PAYOFF
Bonus Certificate
10% Bonus with 74% Barrier
200
210
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
190
200
R
e
d
e
m
p
t
i
o
n

P
r
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c
e
e
d
s
Nick Motson
20
0
10
20
30
0 20 40 60 80 100 120 140 160 180 200
Share Price
Buy Underlying Barrier Not Touched Barrier Touched
BONUS CERTIFICATE
STRUCTURI NG
This looks impossible doesnt it?
The return is always higher than buying the The return is always higher than buying the
underlying
Where does the free bonus come from?
There is no such thing as a free lunch (think
back to weeks 1 & 4)
Can you see any familiar option payoffs?
Nick Motson
21
Can you see any familiar option payoffs?
159
BONUS CERTIFICATE
STRUCTURI NG
Bonus Certificate
Structure
190
200
210
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
190
P
a
y
o
f
f
Nick Motson
22
0
10
20
30
0 20 40 60 80 100 120 140 160 180 200
Share Price
Buy Zero Strike Call Buy Down & Out Put Combi ned
BONUS CERTIFICATE
STRUCTURI NG
BONUS CERTIFICATE
LONG
ZERO STRIKE
CALL
=
+
Nick Motson
23
LONG
DOWN & OUT
PUT
160
ZERO STRIKE CALL?
What is a zero strike call?
A call that is guaranteed to be exercised A call that is guaranteed to be exercised
What is the theoretical price of this?
Simply a forward that you pay for today rather
than in at maturity
What drives the price of the forward?
Think back to Lecture 1
Nick Motson
24
Think back to Lecture 1
Interest rates (we pay today so no impact)
Income from asset (dividends!)
BONUS CERTIFICATE
STRUCTURI NG
What type of stocks will this work for?
High Dividend Yield
Cheaper zero strike call (pushes down the forward)
High Volatility
The zero strike call is insensitive to volatility
Nick Motson
25
The zero strike call is insensitive to volatility
The down & out put is short vega (remember the
spreadsheet you played with on week 3)
161
BONUS CERTIFICATE
STRUCTURING ZERO STRIKE CALL
ZERO
STRIKE
CALL CALL
COSTS
95.56%
DRIVEN BY
IMPLIED
FORWARD
WHICH IN
TURNIS
Nick Motson
26
TURN IS
DRIVEN BY
THE
DIVIDEND
BONUS CERTIFICATE
STRUCTURING DOWN & OUT PUT
A VANILLA
PUT
WOULD WOULD
COST
NEARLY
25%
Nick Motson
27
162
BONUS CERTIFICATE
STRUCTURING DOWN & OUT PUT
DOWN &
OUT PUT
ONLY ONLY
COSTS
1.66%!!
Nick Motson
28
CAPPED BONUS CERTIFICATE
EXAMPLE
Nick Motson
29
163
1
Bonus Certificate linked to SX5E with 65.00% Barrier,
14.50% Bonus Amount and a Cap at 140.00%
Final Termsheet
Product Description
This Bonus Certificate is a EUR denominated certificate linked to the Dow Jones EURO STOXX 50 Price
Index
. The Bonus Certificate offers at maturity a payout linked to the development of the Underlying during its
lifetime. If the Underlying has never during its lifetime traded at or below the Barrier Level, the Bonus Certificate
pays out at maturity the Issue Price times (a) the positive performance of the Underlying up to the cap or (b) if
the positive performance is below the Bonus Amount at least the Bonus Amount (100% + 14.50%). However, if
the Underlying has traded at any time during its lifetime at or below the Barrier Level, the investor will receive a
cash amount equal to the Issue Price times the Performance up to the Cap on the Final Valuation Date.
The Bonus Certificate is not capital protected. The Investor faces the risk of a negative performance of the
Underlying and can, accordingly, lose up to 100% of the initial investment. The Bonus Certificates are
interesting for investors who expect the Underlying to perform around the current level.
April 22, 2008
Issuer Deutsche Bank AG, Frankfurt (S&P: AA, Moodys: Aa1)
Issue Volume Up to 10,000 Bonus Certificates
Issue Price EUR 1000
Underlying DJ Euro Stoxx 50 Price Index
ISIN: EU0009658145
Bloomberg: SX5E
Initial Valuation Date April 22, 2008
Payment Date April 29 , 2008
Expected beginning of
Trading on the SWX
April 29 , 2008
Last Trading Day April 22, 2010
Final Valuation Date April 22, 2010
Settlement Date April 29, 2010
Initial Reference Level (IRL) EUR 3736.12
(100.00% of the official closing price of the Underlying on Initial Valuation
Date)
Final Reference Level (FRL) 100% of the official closing price of the Underlying on Final Valuation Date
Performance Final Reference Level (FRL) / Initial Reference Level (IRL)
Barrier Level EUR 2428.48 (65.00% of Initial Reference Level)
Bonus Amount 14.50%
2
Final Termsheet
Cap 140%
Redemption The Issuer owes each holder of a Bonus Certificate a redemption amount
according to the conditions of the Bonus Certificate:
1. If the Underlying has never during the Barrier Period traded at or
below the Barrier Level the redemption amount shall be equal to the
Issue Price times (a) the positive performance of the Underlying up to
the cap or (b) if the positive performance is below the Bonus Amount
at least the Bonus Amount:
Issue Price x min[Cap,max(1 + Bonus Amount, Performance)]
2. If the Underlying has traded at or below the Barrier Level at any time
during the Barrier Period, the holder will receive a cash amount equal
to the Issue Price times the Performance up to the Cap per Bonus
Certificate
Issue Price x min [Cap,Performance]
Barrier Event A Barrier Event is deemed to have occurred if during the Barrier Period, the
price of the Underlying Index is equal to or lower than its Barrier Level. The
Barrier Level is observed continuously.
Barrier Period From April 22, 2008 to April 22, 2010 (both including).
Settlement Cash
Index Sponsor Dow Jones
Minimum Trade Size 1 Bonus Certificate
Tax No Swiss withholding tax. No Swiss federal stamp duty at issuance (primary
market). Swiss federal turnover stamp duty on secondary market
transaction. The certificate is classified as transparent ( IUP = Interest
Unique Predominant). The difference between the Issue Price and its
present value (EUR 1000 - EUR 86.49 = EUR 913.51, IRR 4.6270%,) is
classified as interest income and subject to Swiss income tax for individuals
having their tax residence in Switzerland and holding the Certificate as part
of their private property. The aforementioned tax treatment is valid at the
time of launch of the issue and is not exclusive. The relevant tax laws and
the administration practice are subject to change. Deutsche Bank AG
expressly excludes all liability in respect of any tax implications.
EU Savings Tax Treatment For Swiss paying agents, this product is not in scope (TK2).
Governing Law/Jurisdiction ENGLISH LAW/LONDON
Clearing Agent SIS SegaInterSettle
Selling Restrictions United States, US Persons, the United Kingdom, European Economic Area,
Canada and Japan
Calculation / Primary Paying
Agent
164
3
Final Termsheet
Secondary Paying Agent Deutsche Bank AG, Zurich Branch
Listing Application will be made for listing at SWX Swiss Exchange.
Market Making Under normal market conditions, it is foreseen that Deutsche Bank AG,
Frankfurt will quote bid/offer prices for this product on the SWX Swiss
Exchange
SVSP Product Type 380 Bonus Certificate with Cap
Valoren 3897818
ISIN DE000DB3BYB3
Ticker ESBDB
Reuters Ric ESBDB=DBBL
In connection with the offer and sale of the Notes, the distributor may acquire the Notes from the Issuer at a discount to the Issue Price or at
the Issue Price. If the distributor acquires the Notes at the Issue Price, the Issuer may pay to the distributor a distribution fee. Such fees
received by the distributor may be in addition to the brokerage commissions/fees normally applied by the distributor. The investor
acknowledges and agrees that such fees are retained by the distributor. Further information is available from the distributor upon investor's
written request.
If applicable, the distributor may receive a portion of the management fee on a recurring basis (trailer fees) for efforts undertaken by the
distributor for placement/distribution of the Notes and other services rendered. The investor acknowledges and agrees that such fees are
retained by the distributor. Further information is available from the distributor upon investor's written request.
In receiving payments by third parties, the distributors interests may be adverse to those of the holders of this investment product and such
payments could therefore adversely affect the investors return on the investment product.
Disclaimer
Product Risks: The Securities are derivative financial instruments. An investment in the Securities entails risks similar to a direct
investment in the Underlying. This is an investment in an emerging market. The investor bears a foreign exchange risk. An investment in the
Securities could result in a total loss of the invested capital.
Issuer Risk: The investors bear the credit risk of Deutsche Bank AG as issuer of the Securities. The value of the Securities depends not
only on the performance of the Underlying but also on the solvency of the Issuer, which may vary over the lifetime of the Securities. The
"Securities"). The complete terms and conditions are included in the Offering Circular. Capitalized terms which are not defined herein have
the same meaning as in the Offering Circular. The facts contained herein are merely for information purposes. This document, and the
information contained therein, does not constitute an issue prospectus according to the articles 652a and 1156 of the Swiss Code of
Obligation ("CO"). Only the terms and conditions included in the Offering Circular, which can be obtained free of charge at Deutsche Bank
AG, Zurich Branch, P.O. 3604, 8021 Zurich, are binding.
4
Final Termsheet
performance is not indicative of future results.
offered or sold in the United States, the UK, Canada, Japan, the European Economic Area or to US Persons
Disclaimer for DJ EURO Stoxx 50 Price Index
The Dow Jones STOXX 50 Price Euro
is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland
and/or Dow Jones & Company, Inc., a Delaware corporation, New York, USA, (the "Licensors"), which is used under license. The securities
based on the Index are in no way sponsored, endorsed, sold or promoted by the Licensors and neither of the Licensors shall have any
liability with respect thereto.
165
PAYOFF
Capped Bonus Certificate
14.5% Bonus with 65% Barrier & 140% Cap
200
210
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
190
R
e
d
e
m
p
t
i
o
n

P
r
o
c
e
e
d
s
Nick Motson
30
0
10
20
30
0 20 40 60 80 100 120 140 160 180 200
Share Price
Buy Underlying Barrier Not Touched Barrier Touched
STRUCTURI NG
Capped Bonus Certificate
Structure
180
200
220
20
0
20
40
60
80
100
120
140
160
180
0 20 40 60 80 100 120 140 160 180 200
P
a
y
o
f
f
Nick Motson
31
-80
-60
-40
-20 0 20 40 60 80 100 120 140 160 180 200
Share Price
Long Zero Strike Call Long Down & Out Put Short Call Combi ned
166
STRUCTURING
=
LONG
ZERO STRIKE
CALL
LONG
DOWN & OUT
PUT
+
Nick Motson
32
PUT
SHORT
OUT OF THE MONEY
CALL
+
THE SCOOP EXAMPLE
SLIDES WILL BE ON MOODLE
AFTER THE LECTURE
AS THIS WAS YOUR HOMEWORK!
Nick Motson
33
167
As we discussed last week the art of structuring is
putting together component parts that sum to less than
the cost of the product and provide a payoff profile that
is still attractive to investors.
You will recall that for Growth Products this involved
Varying the level of capital protection
Varying the option payoff
For Yield Products this involves
Nick Motson
34
Varying the level of downside protection
Selecting stocks or baskets that can provide a
high yield (high volatility & high dividend)
SECONDARY MARKET
Growth products with a capital guarantee that
we covered last week have a floor price due
to the zero coupon bond &the delta gets to the zero coupon bond & the delta gets
smaller as the price falls (long gamma
because long options)
This is NOT the case for yield products
The only floor price is ZERO
Nick Motson
35
The only floor price is ZERO
Your Delta increases as the price falls
Approaching barrier if short knock-in or long knock out
168
YIELD vs GROWTH PRODUCTS
GROWTH
PRODUCTS
YIELD
PRODUCTS
LONGER DATED
SHORTER DATED
MATURITY
LONGER DATED
(NEED DISCOUNTING OF ZERO COUPON
BOND)
SHORTER DATED
(NO ZERO COUPON BOND)
UNDERLYING
USUALLY AN INDEX OR
BASKET
(BUYING OPTIONS SO NEED LOWER
VOLATILITY)
USUALLY
INDIVIDUAL
STOCKS
(SELLING OPTIONS OR BUYING
EXOTICS SO NEED HIGH
VOLATILITY)
Nick Motson
36
VOLATILITY)
RISKS
LIMITED TO LOST
INTEREST
CAPITAL AT RISK
ISSUANCE OF GROWTH & YIELD PRODUCTS
High Yields & Low Volatility Make it easy
to Offer Attractive Growth Products
60%
70%
8%
9%
20%
30%
40%
50%
60%
I
m
p
l
i
e
d

V
o
l
a
t
i
l
i
t
y
3%
4%
5%
6%
7%
5

Y
e
a
r

I
n
t
e
r
e
s
t

R
a
t
e
Nick Motson
37
Low Yields & High Volatility Make it easy
to Offer Attractive Yield Products
0%
10%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
0%
1%
2%
Implied Volatility 5 Year Swap Rate
169
TIPS FOR YOUR COURSEWORK
SLIDES WILL BE ON MOODLE
AFTER THE LECTURE
Nick Motson
38
HOMEWORK THIS WEEK
Compulsory
Study the 2 attached term sheets:
1 Merrill 3 Year CHF 8 05% Coupon Worst of Reverse Convertible 1. Merrill 3 Year CHF 8.05% Coupon, Worst of Reverse Convertible
Note on SMI, Eurostoxx 50, S&P 500 and FTSE 100
2. SG - Condor Note Worst Of HSBC / Barclays / RBS / BNP / Citigroup /
Merrill Lynch
Attempt to draw the payoff diagrams and try to determine the
component parts involved in structuring these products
The yields look attractive (especially the SG product) how is this
achieved?
O ti l
Nick Motson
39
Optional
How to Invest in Structured Products A Guide for Investors and
Asset Managers by Andreas Blumke
Pages 43-115
170

Eksportfinans - Aaa
3 Year CHF 8.05% Coupon p.a.
Worst of Reverse Convertible Note on
SMI, Eurostoxx 50, S&P 500 and FTSE 100
ISIN: XS0349835180
General Terms:
Issuer:
Eksportfinans ASA
Rating:
Moodys Aaa, Fitch AAA
Type of Security:
European Medium Term Note
Security Codes: ISIN: XS0349835180 Valor: 3817775 WKN: A0TR12
Trade Date:
21 February 2008
Issue Date:
04 March 2008
Final Valuation Date:
25 February 2011
Maturity Date:
04 March 2011 (subject to call)
Currency:
Quanto CHF
Issue size:
CHF 11,000,000
Denomination:
CHF 10,000
Issue Price:
100%
Payout at Maturity:
Name Bloomberg Code Strike Level Barrier Level (50%)
DJ Eurostoxx 50 SX5E Index 3,778.21 1,889.12
S&P 500 SPX Index 1,342.53 671.27
Swiss Market Index SMI Index 7,486.15 3,743.08
Underlying Indices:
FTSE 100 Index UKX Index 5,932.2 2,966.10
Redemption Amount:
1) If the price of any of the Underlying Indices has NOT been strictly less than the Barrier Level
any time on any Exchange Business day from the Trade Date to and including the Final Valuation
Date:
Then the investor will receive 100% of the Denomination in cash
2) If the price of any of the Underlying Indices has been strictly less than the Barrier Level at any
time on any Exchange Business day from the Trade Date to and including the Final Valuation
Date:
Then if
-On the Final Valuation Date the 4 Underlying Indices close at or above of their respective Strike
Level, the investor will receive 100% of the Denomination in Cash on the Maturity Date
-On the Final Valuation Date one or more of the Underlying Indices closes below its respective
Strike Level then Redemption will be in cash as follows:
Denomination *
Initial
Final
WORSTOF
OF WORST

WORST OF: the worst performing Index calculated as Indexf / Indexi for each underlying index
Indexf: = The closing value of the relevant underlying index on the Final Valuation Date
Indexi = The Strike Level for the relevant underlying index
WORST OF final: The closing value of the WORST OF index on the Final Valuation Date
WORST OF initial: The closing value of the WORST OF index on the Trade Date
For the avoidance of doubt, the Coupons will be paid in any case

Eksportfinans - Aaa
ISIN: XS0349835180
Callability:
Autocall: If all indices are above 90% of their Strike Levels on the respective observation dates, the note
will be called at 100% on the following Interest Payment Date.
Observation Dates: 04 February 2009; 04 February 2010; 04 February 2011
Interest:
Fixed Coupon Amount: 8.05%; an amount of CHF 805 will be paid out per denomination at each Interest payment date
Interest Payment Dates
(subject to call):
04 March 2009; 04 March 2010; 04 March 2011
Day Count Fraction:
TARGET and Zurich
Business Day
Convention:
Modified Following Business Day Convention
EU Savings Tax
Treatment:
For Swiss paying agents, the product is subject to the EU Savings tax (TK6)
Interest Premium:
2.50% p.a. (taxable)
Option Premium:
5.55%
Business Day
Convention:
Modified Following Business Day Convention
Dealer:
Merrill Lynch International
Calculation Agent:
Governing Law:
New York Law
Business Days:
New York, Zurich, London
Clearing:
Euroclear / Clearstream
Delivery:
Against payment
Listing:
None
Secondary Market:
Under normal market conditions, Merrill Lynch International will make a daily secondary market in
the notes on a best effort basis.
Secondary Market Prices include accrued interest (dirty)
Sales Restrictions:
United States. The notes will not be registered for public sale in any jurisdiction and so will be
available only in accordance with applicable, available, private offering rules.
European Union: No Prospectus (as defined in the EU Prospectus Directive 2003/71/EC
(Prospectus Directive)) will be prepared in connection with the notes. Accordingly, the notes may
not be offered to the public in any European Economic Area (EEA) member state and any
purchaser of the certificates who subsequently sells any of their notes in any EEA member state
must do so only in accordance with the requirements of the Prospectus Directive as implemented
in that member state.
Contact: Martin Kummer
Email:
martin_kummer@ml.com
Telephone:
0044 20 7996 1111
Disclaimers:
This communication is furnished at the request of the recipient for the exclusive purpose of identifying the
nature of the security or other instrument referred to herein. It is furnished for your private information with the
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accurate or complete and it should not be relied upon as such. Any written offer of such security may be made
only by means of the Offering Documents or similar document and any related supplements thereto. The
171

Eksportfinans - Aaa
ISIN: XS0349835180
security referred to herein may involve a high degree of risk, which may include principal, interest rate, index,
currency, credit, political, liquidity, time value, commodity and market risk and is not suitable for all investors.
We or our affiliates may buy or sell securities or have long or short positions in securities economically related
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Merrill Lynch International will not be responsible for the consequences of reliance upon any statement or
information contained herein or any omission herefrom. We make no representation and have given you no
advice concerning the appropriate accounting treatment or possible tax consequences of this indicative
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investing in the certificates.
The certificates have not been registered for public sale in any jurisdiction and are therefore available only in
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Fees and Commissions are payable in relation to this product. Details of those fees and commissions are
available to you upon your request.

172
x CONCEPT
At maturity, if NONE of the stocks has closed at or below 51.60% of their respective initial
level during the whole life of the product, the investor receives 100% of his capital plus the
performance of the worst performer with a minimum of 100%.
i 1
st
Case: NONE of the stocks has closed at or below 51.60% of their respective initial level
during the whole life of the product
The holder is redeemed at maturity at the Maximum between:
200% of the nominal
AND
100% + Performance of the Worst performer
Example: We assume an initial level of the Worst Performer at 100%.
Level of the Worst performer at Maturity Redemption at Maturity
66% (-34%) 200%
100% (0%) 200%
140% (+40%) 200%
220% (+120%) 220%
i 2
nd
Case: At least ONE of the stocks has closed at least once at or below 51.60% of its initial
level during the life of the product.
The holder receives the nominal amount accrued or reduced by any increase or decrease
of the Worst Performer
Example: We assume an initial level of the Worst Performer at 100%
Level of the Worst performer at Maturity Redemption at Maturity
50% (- 50%) 50%
60% (- 40%) 60%
80% (-20%) 80%
150% (+50%) 150%
220% (+120%) 220%
x WARNING
Capital is not guaranteed. In case of a decrease of the underlying, this product includes an element of
equity risk and should not be considered as a capital guaranteed product.
Risk Rating
Condor Note Worst OF
2 Years USD
HSBC / Barclays / RBS / BNP / Citigroup / Merrill Lynch
Terms and Conditions
x ADVANTAGES/DRAWBACKS

Advantages
i Capital Gain unlimited: The Condor Note allows the investor to
benefit from the full upside of the Worst performer (even if the
51.60% level is reached on close during the life of the product).
i If NONE of the stocks has closed at or below 51.60% of their
respective initial level, the investor benefits from a minimum
redemption of 200%.
i Full protection up to a 48.40% drop of the Worst performer on
close.
Drawbacks
i The capital is not guaranteed, 100% of the nominal invested is at
risk.
i The investor accepts a potential equity risk, if the spot moves in
the opposite direction to his anticipations.
i The redemption of the product at maturity is dependant on the
worst performing stock.
173
Issuer BNP Paribas Arbitrage Issuance B.V.
Guarantor BNP Paribas (AA+ / Aa1)
Type Certificate
Currency USD (Quanto)
Nominal USD 2,138,000
Denomination USD 1,000
Launch date March 12
th
, 2008
Initial observation date March 12
th
, 2008
Payment date March 26
th
, 2008
Final observation date March 12
th
, 2010
Maturity date March 26
th
, 2010
Issue price 100% of the nominal
Underlying
k Stock (k) Bloomberg Code
Strike Price
(Stock k,i)
Barrier Level
(51.60%)
1 HSBC Holding PLC HSBA LN Equity GBp 795.50 GBp 410.4780
2 Barclays PLC BARC LN Equity
GBp 460.75
GBp 448.7152
GBp 237.7470
GBp 231.5370
3 Royal Bank of Scotland RBS LN Equity
GBp 358.75
GBp 307.9223
GBp 185.1150
GBp 158.8879
4 BNP Paribas BNP FP Equity EUR 59.54 EUR 30.7226
5 Citigroup Inc C UN Equity
USD 21.21 USD 10.9444
6 Merrill Lynch & Co Inc MER UN Equity
USD 44.92 USD 23.1787
Final Price (Stock k,f) Official closing Price of the Stock k on the Final observation date
Worst Performer
Underlying
The Worst Performer Underlying is defined as the Underlying that has the Worst
Performance at the date t
Worst Performance Min
6
(Stock k,t /Stock k,i)
Avec:
Stock k,i = Official Closing Price of the Stock k on the Initial observation date
Stock k,t = Official Closing Price of the stock k on date t
Worst Peformance (f) = Worst Performance on Final observation date
Risk Rating
Condor Note Worst OF
2 Years USD
HSBC / Barclays / RBS / BNP / Citigroup / Merrill Lynch
Redemption at maturity On maturity date, the holder of the notes will receive:
x If None of the Stock (k) has closed at or below their Barrier Level during the
whole life of the product, the investor will receive the MAXIMUM of the 2
following amounts:
% 200 on Denominati u
(f) Peformance Worst on Denominati u
x If at least ONE of the Stock (k) has closed at or below its Barrier Level during
the life of the product, the investor will receive the following amount:
(f) Peformance Worst on Denominati u
Business Day
Convention
Modified Following Business Day
Calculation Agent BNP Paribas Arbitrage S.N.C.
Listing None
Selling conditions This issue does not constitute a public offer of securities and has not been subject to the
clearance procedures of competent authorities
Secondary Market
Under normal market conditions a daily Bid/Offer price will be quoted on the secondary
market with a 1,00% spread.
If the requested trading size is too large in view of the liquidity of the underlying asset or
volatility abnormally high, the relevant calculation agent keeps the possibility, at its
discretion, to widen the Bid/Offer spread.
The Bid/Ask Price of the Product includes the accrued interest that the Investor is entitled to
receive (Dirty Price)
Risks Factors The investor is well aware that the product is built with the purchase of stocks and the sale
of options. It can in no way be considered a capital guaranteed product. The Secondary
market valuation of the Product may strongly be affected according to interest rates
movements, Dividend payments, Underlying fluctuations, market Volatility.
Moreover, SG Private Banking indicates that the Guarantor of this Structured Product has a
credit rating and a credit spread that might change over time, this affecting the secondary
market price. Also the investor should be aware that the redemption at maturity of such
Structured Product is subject to the non occurrence of any credit event or event of default
affecting the Guarantor during the life of the Structured Product.
Settlement Clearstream/Euroclear
174
Disclaimer This material is intended to report solely on the investment strategies and opportunities
identified by SG Private Banking Structured Products Solutions
It is intended for publication and distribution to the recipient only and may not be passed on
or disclosed to any other persons. It is the responsibility of any person in possession of this
document to investigate and observe all applicable laws and regulation of relevant
jurisdiction.
The price and value of financial products and the income derived from them can go down as
well as up. Changes in the exchange rate may have an adverse effect on the value, price and
income of financial products in a currency other than your own.
The information may be subject to change with market fluctuations.
Prospective investors should rely on the information contained in the detailed documentation
(prospectus, term sheet, fact sheet) available for this/these specific product(s), especially
with regard to the associated risks.
Past performance should not be seen as an indication of future performance.
Any services and investments referred to may have tax, legal or accounting consequences
and it is important to bear in mind that we do not provide such advice. You should seek
professional advice in order to understand any applicable tax, legal or accounting
consequences related to your particular circumstances.
175
Lecture6 Commodity Lecture 6 Commodity
Derivatives
Nick Motson
1
People who know how much they're worth aren't usually worth
that much Nelson Bunker Hunt
176
INTRODUCTION
In Lecture 1 we covered the principle of
hedging commodity price risks using futures
and/or forwards and/or forwards
Remember Mr Kellogg
This week we will cover the use of commodity
derivatives in investment
Nick Motson
2
INTRODUCTION
Reasons Given for Including commodities
in a portfolio
Diversification: Historically low correlation with
other asset classes
Store of value: Can perform well in periods of
rising inflation and interest rates
Performance: Can significantly improve portfolio
Nick Motson
3
g
performance
177
HOW TO INVEST IN COMMODITIES
Physical?
Buying commodities and storing
Cumbersome and expensive
Resource Stocks?
Broad equity market exposure
Business risk
Cumbersome and expensive
Prices tend to mean-revert
Commodity Futures?
Requires monthly rolls
Operational risks
Discounted cash flows
Tend to under-perform especially
when commodity prices are volatile
Commodity Index?
Majority investments are made via
the Goldman Sachs Commodity
I d
Nick Motson
4
Operational risks
Admin Intensive
Index
Long-only passive index
Tracks performance of a diversified
basket of commodity futures
Transparent, liquid etc
DIVERSIFICATION
1.00
1.0
Total Return Correlation, (8/31/99 - 8/31/09)
Historically low correlation with other asset classes
0.19
0.13
0.35
0.04
0.03
0 2
0.0
0.2
0.4
0.6
0.8
Nick Motson
5
Source: Morningstar, Inc. as of 08/31/09 Commodities are represented by the S&P GSCI. US stocks, real estate, international stocks, bonds and cash
are represented by the S&P 500, MSCI US REIT Index, MSCI EAFE Index, Lehman Brothers Aggregate Bond Index and the 3-month Treasury bill,
respectively.
-0.2
Commodities US Stocks Real Estate
(REITs)
International
Stocks
Bonds Cash
178
STORE OF VALUE
35%
40%
Commodities Stocks
Average Annual Total Return, (3/31/72 - 6/30/09)
Commodities have performed well when inflation increases
22.76%
0 70%
27.25%
11.78%
17.43%
7.03%
0%
5%
10%
15%
20%
25%
30%
A
n
n
u
a
l
i
z
e
d
a
v
e
r
a
g
e
t
o
t
a
l

r
e
tu
r
n
Nick Motson
6
Source: DeutscheBank
Commodities and stocks are represented by the S&P GSCI and the S&P 500 Index, respectively. Performance during inflationary periods is defined
as follows: above/below refers to G-7 CPI inflation growth relative to average inflation growth rate for the period fromMarch 31,1972 through J une
30, 2009; rising/falling refers to the G7-CPI inflation growth rate relative to the year-ago inflation growth rate.
-3.59%
-0.70%
-2.05%
-10%
-5%
Belowand Falling Belowand Rising Above and Falling Above and Rising
PERFORMANCE
Commodities and Other Asset Classes
Commodities and other asset classes
1000
J an-70 =100
Commodities Indices have had equity-like returns
1
10
100
1000
Nick Motson
7
Source: Bloomberg, Bank of America Merrill Lynch CommodityResearch
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
S&P 500 S&P GSCI ML US Broad Market Bond Index Cash
179
COMMODITY INDICES
Major Commodity Indices
First Generation First Generation
Standard & Poors Goldman Sachs Commodity Index, 1991
Dow J ones-AIG Commodity Index, 1991
Second Generation
Deutsche Bank Commodity Index, 2003
Lehman Brothers Commodity Index, 2006
Merrill Lynch Commodity Index, 2006
Rogers International Commodity Index 2005
Nick Motson
8
Rogers International Commodity Index, 2005
S&P GSCI + DJ -AIG DOMINATE
Nick Motson
9
180
S&P GSCI COMPONENTS AND WEIGHTS
Energy
(78.36%)
Metals
(7.29%)
Agriculture
(14.35%)
Crude Oil
(55.45%)
Aluminum
(2%)
Wheat
(3.8%)
Natural Gas
(7.43%)
Copper
(2.4%)
Corn
(3.6%)
Heating Oil Soybeans
Nick Motson
10
(5.48%)
(2%)
Live Cattle
(1.6%)
DOW J ONES-AIG COMPONENTS AND
WEIGHTS
Energy
(33%)
Metals
(30.09%)
Agriculture
(31.06%)
C d Oil I d i l M l G i Crude Oil
(20.76%)
Industrial Metals
(19.97%(
Grains
(18%)
Natural Gas
(12.24%)
Precious Metals
(10.12%)
Livestock
(7.44%)
Vegetable Oils
Nick Motson
11
(2.81%)
181
HOW ARE THE WEIGHTS
DETERMINED?
S&P GSCI
The S&P GSCI is world-production weighted; the quantity of
each commodity in the index is determined by the average y y g
quantity of production in the last five years of available data
DOW J ONES-AIG
The DJ -AIG relies primarily on liquidity data, or the relative
amount of trading activity of a particular commodity. The
index also relies to a lesser extent on dollar-adjusted
production data. The index thus relies on data that is
Nick Motson
endogenous to the futures markets (liquidity) and exogenous
to the futures markets (production) in determining relative
weightings. Similar to the GSCI both the liquidity and
production are averaged over a five-year period.
12
SO WHY ARE THE WEIGHTS SO
DIFFERENT?
Because the S&P GSCI uses production weights it means it is
heavily biased towards consumption commodities. This is
why is it around 3 quarters energy.
The use of liquidity weighting means that the DJ -AIG is less
biased towards consumption commodities, it also has a
number of rules designed to ensure diversified commodity
exposure:
No related group of commodities (e.g., energy, precious metals,
livestock and grains) may constitute more than 33% of the
i d
Nick Motson
index
No single commodity may constitute less than 2% or more than
15% of the index
13
182
SHOULD COMMODITIES GENERATE
EQUITY LIKE RETURNS?
There is a wealth of academic research on the
question as to whether commodities have a
risk premium and the debate continues risk premium and the debate continues
However one thing is clear and that is that
indices such as the S&P GSCI have produced
equity like returns
To some extent this is because the GSCI is
Nick Motson
To some extent this is because the GSCI is
actually a trading strategy rather than a passive
index
14
COMPONENTS OF COMMODITY
INDEX RETURN
The S&P GSCI Total Return index
measures a fully collateralized commodity
futures investment that is rolledforward futures investment that is rolled forward
from the fifth to the ninth business day of each
month. Currently the S&P GSCI includes 24
commodity nearby futures contracts. The S&P
GSCI Total Return is significantly different
than the return frombuying physical
Nick Motson
15
than the return from buying physical
commodities.
183
INDEX RETURN
The S&P GSCI Spot index tracks the price
of the nearby futures contracts, not returns
available to investors At the end of every available to investors. At the end of every
business day, the S&P GSCI is composed of
the same proportions by weight of the
underlying commodities and expirations as the
portfolio represented by the S&P GSCI Excess
Returns.
Nick Motson
16
Returns.
INDEX RETURN
9,000
10,000
11,000
2 000
3,000
4,000
5,000
6,000
7,000
8,000
Nick Motson
17
0
1,000
2,000
1
9
6
9
1
9
7
0
1
9
7
1
1
9
7
2
1
9
7
3
1
9
7
4
1
9
7
5
1
9
7
6
1
9
7
7
1
9
7
8
1
9
7
9
1
9
8
0
1
9
8
1
1
9
8
2
1
9
8
3
1
9
8
4
1
9
8
5
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
GSCI SPOT COMMODITY INDEX GSCI TOTAL RETURN INDEX
184
INDEX RETURN
The S&P GSCI Excess Return measures
the return from investing in nearby S&P GSCI
futures and rolling themforward each month futures and rolling them forward each month
(on the fifth to ninth business days of each
month), always keeping your investment in
nearby futures. This is a leveraged futures
investment.
Nick Motson
18
INDEX RETURN
9,000
10,000
11,000
2 000
3,000
4,000
5,000
6,000
7,000
8,000
Nick Motson
19
0
1,000
2,000
1
9
6
9
1
9
7
0
1
9
7
1
1
9
7
2
1
9
7
3
1
9
7
4
1
9
7
5
1
9
7
6
1
9
7
7
1
9
7
8
1
9
7
9
1
9
8
0
1
9
8
1
1
9
8
2
1
9
8
3
1
9
8
4
1
9
8
5
1
9
8
6
1
9
8
7
1
9
8
8
1
9
8
9
1
9
9
0
1
9
9
1
1
9
9
2
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
GSCI EXCESS RETURN INDEX GSCI TOTAL RETURN INDEX
185
INDEX RETURN
Spot/ price return
Changes in nearby futures prices
Commodities often have positive exposure to event Commodities often have positive exposure to event
risk (e.g., supply shocks a prime determinant of
price)
Collateral return/ yield
Treasury yield earned if 100% margin is invested in
treasuries during the life of the futures contract
Roll return/ yield
Nick Motson
Roll return/ yield
Change in futures prices not attributable to the
change in spot prices
20
A COMMENT ON ROLL RETURN
If the commodity is in backwardation
Roll yield is positive (always rolling to buy a future
that is cheaper than the one you are selling)
If the commodity is in contango
Roll yield is negative (always rolling to buy a future
that is more expensive than the one you are selling)
As energy futures have traditionally been in
Nick Motson
gy y
backwardation (remember normal
backwardation) then perhaps this is why the
GSCI is so heavily energy weighted?
21
186
SIGNIFICANCE OF COMMODITY INDEX
FUNDS
From the end of 2003 to March 2008 investments in commodity
index funds have increased from $13 billion to $260 billion!
Nick Motson
Source: Mike Masters Congressional Testimony
22
SIGNIFICANCE OF COMMODITY INDEX
FUNDS
$bn Share $bn Share
C d il 51 0 26 6% C 0 8 14 1%
I NDEX FUND VALUES AND SHARE OF OPEN I NTEREST J une 2008
Crude oil 51.0 26.6% Cocoa 0.8 14.1%
Gasoline 8.0 23.9% Coffee 3.1 25.6%
Heating oil 10.0 34.5% Cotton 2.9 21.5%
Natural gas 17.0 14.7% Sugar 4.9 31.1%
Copper 4.4 41.7% Feeder cattle 0.6 30.7%
Gold 9.0 22.7% Live cattle 6.5 41.8%
Silver 2.3 20.1% Lean hogs 3.2 40.6%
Nick Motson
23
Corn 13.1 27.4% Other U.S. markets 1.4
Soybeans 10.9 20.8% Total (U.S. markets) 161.5 25.8%
Soybean oil 2.6 21.7% Non-U.S. markets 38.4
Wheat 9.7 41.9% Overall total 199.9
Source: CFTC
187
George Soros
J une 2008
BUBBLE?
Nick Motson
24
COMMODITY LINKED
STRUCTURED NOTES
Nick Motson
25
188
INTRODUCTION
Sales of commodity-linked notes rose to $15.8 billion
over the first half of 2008, up from $7.8 billion over the
same period a year ago, according to MTN-I, which is a
d t d id f i t l t d data and news provider for private placement and
structured fixed-income markets. Reported deals
numbered 648 over the six months ended J une 30, as
opposed to 463 the year before.
Over that same period, however, overall global
structured note sales fell by about 20% to $227 billion
Nick Motson
26
structured note sales fell by about 20%, to $227 billion.
MTN-I officials in a report ascribed the decline to lower
demand for notes linked to rates and equities, the
biggest underlying asset classes
EXAMPLE 1 GOLD BULL NOTE
Nick Motson
27
189

INFORMATION STATEMENT
T
DATED September 21, 2009
T
HSBC BANK CANADA
GOLD - LINKED DEPOSIT NOTES,
SERIES 1, BULL CLASS
DUEMARCH28, 2013
PRICE: US $100.00 per Note
MINIMUM SUBSCRIPTION: US $2,000.00 (20 Notes)

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SUMMARY OF THE OFFERING
TAs this is a summary, it may not contain all of the information that may be important to you. You should read the entire Information
Statement carefully before you decide to make an investment in the Notes. Capitalized terms that are used but not defined in this summary
are defined elsewhere in the Information Statement.
Issuer: The Notes will be issued by HSBC Bank Canada (the Bank, HSBC, we, our or us).
Issue:
HSBC Gold-Linked Deposit Notes, Series 1, Bull Class (the Notes) are principal protected
deposit notes issued by HSBC. If held to maturity, the Notes will pay:
x 100% of the Principal Amount invested; and
a Variable Return, if any, linked to the change in the value (positive or negative) of the
spot rate of Gold (the Reference Asset), represented by the price of one troy ounce of
gold, stated in U.S. Dollars (as described below under Reference Price). The
performance (positive or negative) of the Reference Asset will be measured from its Initial
Price determined on the Price Set Date to its Final Price determined on the Valuation Date.
x If the Variable Return is zero or less than zero, then the Notes will not pay a Variable
Return. The actual calculation of Reference Asset Return and Variable Return is described
below under Description of the Notes Variable Return.
Issue Price: The price for each Note is US $100.00 (the Principal Amount) with a minimum subscription of
US $2,000.00 in Notes per holder (each a Noteholder).
Issue Date: The Notes will be issued on or about September 28, 2009.
Price Set Date: On or about September 22, 2009.
Closing Date: On or about September 21, 2009.
Valuation Date: On or about March 22, 2013.
Issue Size: Up to US $10,000,000. HSBC may increase or decrease the size of the offering at its sole discretion.
Maturity Date/Term: The Notes will mature on March 28, 2013 or if such date is not a Business Day then on the next
succeeding Business Day (the Maturity Date), resulting in a term to maturity of approximately
three and a half (3.5) years (the Term).
Maturity Redemption
Amount:
On the Maturity Date, repayment of the full Principal Amount of US $100.00 per Note will be
payable to the Noteholder regardless of the performance of the Reference Asset, plus the Variable
Return, if any (together, the Maturity Redemption Amount), subject to the occurrence of a
Special Circumstance.
Variable Return: The Variable Return, if any, payable on each Note will be calculated using the following formula:
Principal Amount x Participation Rate x Reference Asset Return
If the Variable Return is zero or less than zero, then the Notes will not pay a Variable Return.
Participation Rate: 28%
Reference Asset Return:
Reference Asset Return means, in respect of the Reference Asset, an amount (which may be
positive or negative) expressed as a percentage and calculated as the Final Price minus the Initial
Price, divided by the Initial Price, calculated according to the following formula:
(Final Price - Initial Price)
Initial Price
190

- 4 -

Reference Price:
As of any date of determination and as determined by the Calculation Agent, the price of one troy
ounce of gold, stated in U.S. Dollars, to be determined by reference to the London PM Gold Fixing
(expressed as a number of USD per fine troy ounce of gold) set by the London Gold Market Fixing
Ltd.(the LGM) (or its successor) and published on Reuters Page GOFO at or around 3 p.m. London
time; provided, that if such rate is not timely available for any reason, the rate shall be determined by
the Calculation Agent in its sole discretion, in good faith and in a commercially reasonable manner.
Noteholders will not be a beneficial owner of or have an interest in the Reference Asset. The
return on the Notes will not reflect the return you would realize if you actually owned the Reference
Asset.
Initial Price: The Reference Price of the Reference Asset on the Price Set Date, subject to adjustment in case of an
ongoing Market Disruption Event. See "Calculation Agent- Market Disruption Event".
Final Price: The Reference Price of the Reference Asset on the Valuation Date, subject to adjustment in case of an
ongoing Market Disruption Event. See "Calculation Agent- Market Disruption Event".
Distribution: The Notes will be sold primarily through an affiliate of HSBC, HSBC Securities (Canada) Inc., as
well as through certain other unaffiliated broker or dealers (Selling Agents).
Expenses of the Offering: The Selling Agents will receive from HSBC a fee of up to 1.50% of the aggregate Principal Amount
of the Notes sold as a result of the services of the Selling Agents. These upfront expenses will not
have an effect on the amount payable to the Noteholders. Specifically the fees will not factor into the
formula for, or affect the potential of the Variable Return, if any, which may be payable to
Noteholders on the Maturity Date.
Ongoing Information:
HSBC will also maintain background information with respect to the Notes on its website at
www.hsbcnet.com/spcanada.
Secondary Market and Sale
of the Notes prior to the
Maturity Date:
There is currently no established trading market through which the Notes may be sold. A
Noteholder cannot elect to receive the Principal Amount from HSBC prior to the Maturity Date and
the Notes will not be listed on any exchange. However, Noteholders may be able to sell Notes prior
to maturity in any available secondary market that develops, but no assurances are given that such a
market will develop or that it will be liquid. HSBC Securities (Canada) Inc. (HSBC Securities)
intends, in normal market conditions, but is under no obligation, to use reasonable efforts to provide a
secondary price for the Notes as principal (which price will be determined in the sole discretion of
HSBC Securities), and to obtain prices upon which third parties may be prepared to purchase Notes in
any available secondary market, but reserves the right not to do so in the future in its sole discretion,
without providing prior notice to the Noteholders. Other than any price which HSBC Securities may,
but is under no obligation to, obtain or provide, there is no guarantee that third parties will be
available in any such secondary market, if one exists. HSBC Securities may, from time to time,
purchase and sell Notes but will not be obligated to do so. HSBC Securities will have the right, in its
sole discretion, to cease to purchase or sell Notes. If a secondary market develops, it may be
suspended or discontinued at any time without notice to Noteholders.
Sales of Notes prior to maturity may be subject to an Early Trading Charge which will be equal to
a percentage of the Principal Amount and will be determined as follows:
Time Period Early Trading Charge
Issue Date to and including December 28, 2009
1.50%
December 29, 2009 to and including the Maturity Date
0.00%
If you sell a Note within the first three (3) months from the Issue Date, the proceeds from the sale of
the Note will be reduced by the applicable Early Trading Charge as indicated in the table above.
After 3 months following the Issue Date, there will not be an Early Trading Charge on a sale of your
Notes. See Description of the Notes Secondary Trading of Notes. The Notes are not intended
to be short-term trading instruments and are generally not suitable for an investor who requires
liquidity prior to maturity. You should consult your investment advisor on whether it would be
more favourable in the circumstances at any time to sell the Note on the secondary market (assuming
it is available) or hold the Note until the Maturity Date. You should also consult your tax advisor as
to the income tax consequences arising from a sale of the Notes prior to the Maturity Date as
compared to holding the Notes until the Maturity Date.
Noteholders choosing to sell their Notes prior to the Maturity Date will receive a market price

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which is not necessarily equal to 100% of the Principal Amount and which does not necessarily
reflect any increase in the value of the Reference Asset to the date of such sale, and as a result,
Noteholders may suffer losses. See Risk Factors.
Book-Entry Registration: On the Issue Date, the Notes will be evidenced and issued by way of a single global certificate to be
delivered to and registered in the name of CDS and deposited with CDS. Registrations of interests in
and transfers of Notes will be made only through the Book-Entry system administered by CDS and
must be subscribed, transferred and repurchased through a participant in the depository service of
CDS (a CDS Participant). Subject to certain limited exceptions, no Noteholder will be entitled to
any certificate or other instrument from the Bank or CDS evidencing the ownership thereof, and no
Noteholder will be shown on the records maintained by CDS, except through a CDS Participant. See
Book-Entry System.
Rank: The Notes will constitute direct unsecured deposit obligations of the Bank. The Notes will be issued
on an unsubordinated basis and will rank pari passu as among themselves and will be payable
rateably without any preference or priority. The Notes will not constitute deposits insured under
the Canada Deposit Insurance Corporation Act or under any other deposit insurance regime.
The Notes will not be issued under a trust indenture, and no trustee or other fiduciary for Noteholders
will be appointed.
Calculation Agent: The Calculation Agent will be HSBC Bank USA, National Association. We may appoint a different
Calculation Agent at any time without notice to Noteholders.
Credit Rating of the Issuer: TThe Notes will not be specifically rated by any rating agency. However, as of the date of this
Information Statement, the deposit liabilities of HSBC with a term to maturity of more than one (1)
year wereT rated AA by DBRS and AA by S&P. These ratings represent the rating agencies
assessments of HSBCs creditworthiness and are not indicative of the market risk or liquidity
associated with the Notes or the performance of the Reference Asset. A rating is not a
recommendation to buy, sell or hold investments and may be subject to change or withdrawal at
any time by the relevant rating agency.
Tax Considerations:
There should be no deemed accrual of interest in respect of any Variable Return for any taxation year
of a Noteholder ending before the taxation year in which a minimum amount of Variable Return
payable at maturity becomes calculable. Subject to the limitations outlined under Canadian Federal
Income Tax Considerations, while the matter is not free from doubt, an amount received by a
Noteholder on a disposition or a deemed disposition of a Note (other than a payment by or on behalf
of HSBC) should generally give rise to a capital gain (or capital loss) to such Noteholder at such time
to the extent such amount exceeds (or is less than) the aggregate of such Noteholders adjusted cost
base of the Note and any reasonable costs of disposition. Noteholders who dispose of a Note prior
to the Maturity Date, particularly within a short period of time before the Maturity Date or
pursuant to a private agreement with HSBC or an affiliate, should consult their own tax advisor
with respect to their particular circumstances. See Canadian Federal Income Tax
Considerations.
Redemption Under Special
Circumstances:
Notwithstanding the Maturity Date, the Bank may redeem the Notes prior to maturity under certain
limited circumstances, including a change in the law, regulation, taxation regulations or taxation
practice or other circumstances not within the control of the Bank. See Calculation Agent
Redemption Under Special Circumstances.
Risk Factors to Consider:
The Notes subject the Noteholders to significant risks, including the potential for lost investment
opportunities. Potential Noteholders should carefully review and consider all risks set forth in this
Information Statement (see Risk Factors), including:
x The Notes will not constitute insured deposits;
x The Principal Amount is payable only if Notes are held to maturity;
x Noteholders may not receive a Variable Return;
x There is no guaranteed secondary market for the Notes and if such a market
develops, there can be no assurance that it will be liquid;
x Price or other movements in the Reference Asset are unpredictable;
x Noteholders only participate in 28% of the upside performance of the Reference
Asset;
191

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x Noteholders have no ownership interest in the Reference Asset;
x Notes could be redeemed prior to maturity as a result of Special Circumstances;
x Currency risk; and
x Conflicts of interest.
192
EXAMPLE 1 TERMS
Nick Motson
28
Is This Attractive?
EXAMPLE 1- WHY SUCH LOW
PARTI CI PATI ON?
This is a 3 year
note, so with interest
CAPITAL GUARANTEED
COMMODITY LINKED NOTE
note, so with interest
rates at 3% the zero
coupon bond will cost
approximately 90.
But this alone is not
ZERO COUPON
BOND
LONG CALL OPTION
=
+
Nick Motson
But this alone is not
enough to explain
everything
LONG CALL OPTION
29
193
PARTI CI PATI ON?
The call option has to be ATM spot, but if you think
back to lecture 1, what is the shape of the Gold back to lecture 1, what is the shape of the Gold
forward curve
Contango?
Backwardation?
Nick Motson
30
PARTI CI PATI ON?
An Option that is
at the money at the money
spot will be in
the money
forward making
it very expensive
Forward
Nick Motson
Spot
31
194
EXAMPLE 2
Nick Motson
32
195
"This product is destined to prospective investors who possess sufficient knowledge, based on their own experience, to evaluate the advantages
and the risks inherent to the product. Socit Gnrale and its subsidiaries strongly advise prospective investors to consider, based on the risks
inherent to the product and based on their own judgement or on the recommendations of their professional advisor they have chosen to consult,
the suitability of the product as an investment in the light of their own circumstances and financial condition.
T Th he e i in nf fo or rm ma at ti io on n c co on nt ta ai in ne ed d h he er re ei in n a ar re e i in nd di ic ca at ti iv ve e o on nl ly y a an nd d c ca an n b be e s su ub bj je ec ct t t to o c ch ha an ng ge e w wi it th h m ma ar rk ke et t f fl lu uc ct tu ua at ti io on ns s. . S So oc ci i t t G G n n r ra al le e a an nd d i it ts s s su ub bs si id di ia ar ri ie es s
h ha av ve e u us se ed d t th he ei ir r b be es st t e en nd de ea av vo ou ur rs s t to o p pr re es se en nt t t th he e i in nf fo or rm ma at ti io on n f fa ai ir rl ly y a an nd d a ac cc cu ur ra at te el ly y b bu ut t m ma ak ke e n no o r re ep pr re es se en nt ta at ti io on ns s a an nd d p pr ro ov vi id de e n no o w wa ar rr ra an nt ti ie es s t to o t th ha at t
e ef ff fe ec ct t o or r t to o i it ts s r re el li ia ab bi il li it ty y. .
We offer the following three year investment strategy in USD whereby the capital is guaranteed at
100% at maturity. The investor benefits from an unlimited high yield bonus indexed on 150% of the
appreciation of a basket including Copper, Zinc, Nickel, WTI and Gold.
Issuer To Be Determined (Minimum: AA-, Aa2)
Type EMTN
Currency USD
Nominal USD 3,000,000 Minimum
Denomination USD 1,000
Secondary Market USD 10,000
Launch Date To Be Determined
Strike Date To Be Determined
Payment Date Launch date + 2 weeks
Final Observation
Date
Strike Date + 3 years
Maturity Date Payment Date + 3 years
Issue Price 100% of the nominal
Implied participation 150% of the appreciation of the basket
Underlying A basket of commodities composed as follows :
2/9 Nickel (Ni) Reuters Ticker <<MTLE>>
2/9 Zinc (Zn) Reuters Ticker <<MTLE>>
2/9 Copper (Co) Reuters Ticker <<MTLE>>
1/6 Gold (Gold) Reuters Ticker <<GOFO>>
1/6 WTI (WTI) Reuters Ticker <<SETT>>
Redemption at
maturity
At maturity, the investor receives the maximum between :
Nominal x
+ + + + + 1 6 / 1 6 / 1 9 / 2 9 / 2 9 / 2 % 150 % 100
Initial
WTI
Final
WTI
Initial
Gold
Final
Gold
Initial
Co
Final
Co
Initial
Zn
Final
Zn
Initial
Ni
Final
Ni
And
Nominal x 100%
With :
Initial : Relevant price of each Commodity on Strike Date
Final : Relevant price of each Commodity on Final Observation Date
USD USD USD USD Protected Note Protected Note Protected Note Protected Note 150% 150% 150% 150%
100% Capital Guaranteed 100% Capital Guaranteed 100% Capital Guaranteed 100% Capital Guaranteed
Indexed on a Basket of Commodities Indexed on a Basket of Commodities Indexed on a Basket of Commodities Indexed on a Basket of Commodities
3 Year Maturity 3 Year Maturity 3 Year Maturity 3 Year Maturity

INDICATIVE TERMS AND CONDITIONS INDICATIVE TERMS AND CONDITIONS INDICATIVE TERMS AND CONDITIONS INDICATIVE TERMS AND CONDITIONS
Monday, 17
th
July 2006
Safety
Dynamic
Speculative
100% Capital Guaranteed
"This product is destined to prospective investors who possess sufficient knowledge, based on their own experience, to evaluate the advantages
and the risks inherent to the product. Socit Gnrale and its subsidiaries strongly advise prospective investors to consider, based on the risks
inherent to the product and based on their own judgement or on the recommendations of their professional advisor they have chosen to consult,
the suitability of the product as an investment in the light of their own circumstances and financial condition.
T Th he e i in nf fo or rm ma at ti io on n c co on nt ta ai in ne ed d h he er re ei in n a ar re e i in nd di ic ca at ti iv ve e o on nl ly y a an nd d c ca an n b be e s su ub bj je ec ct t t to o c ch ha an ng ge e w wi it th h m ma ar rk ke et t f fl lu uc ct tu ua at ti io on ns s. . S So oc ci i t t G G n n r ra al le e a an nd d i it ts s s su ub bs si id di ia ar ri ie es s
h ha av ve e u us se ed d t th he ei ir r b be es st t e en nd de ea av vo ou ur rs s t to o p pr re es se en nt t t th he e i in nf fo or rm ma at ti io on n f fa ai ir rl ly y a an nd d a ac cc cu ur ra at te el ly y b bu ut t m ma ak ke e n no o r re ep pr re es se en nt ta at ti io on ns s a an nd d p pr ro ov vi id de e n no o w wa ar rr ra an nt ti ie es s t to o t th ha at t
e ef ff fe ec ct t o or r t to o i it ts s r re el li ia ab bi il li it ty y. .
Copper ($/t) Settlement price at 12:35 (London Time) per tonne of the CASH copper-
Grade A on the LME, stated in U.S. dollars, as determined by the LME and
displayed on page "MTLE" of the Reuters Monitor Money Rates Service.
Zinc ($/t) Settlement price at 12:55 (London Time) per tonne of the CASH Special High
Grade Zinc on the LME, stated in U.S. dollars, as determined by the LME and
Nickel ($/t) Settlement price at 13:05 (London Time) per tonne of the CASH Primary
Nickel on the LME, stated in U.S. dollars, as determined by the LME and
WTI ($/bl) Settlement price per barrel of West Texas Intermediate light sweet crude oil
on the NYMEX of the first nearby Futures Contract, stated in U.S dollars, as
made public by the NYMEX and displayed on page "SETT" of the Reuters
Monitor Money Rates Service.
Gold ($/oz) PM fixing for one troy ounce of Loco London, good London delivery Gold,
stated in USD, as determined by the LBMA (London Bullion Market) and
displayed Reuters page GOFO.
Selling conditions This issue does not constitute a public offer of securities and has not been
subject to the clearance procedures of the competent authorities.
Secondary market The issuer will quote a Bid/Offer price with a 2% spread under normal
market conditions
ISIN To Be Determined
Payment/Delivery Clearstream / Euroclear
Warning
The redemption at maturity can be lower than the redemption of a
monetary deposit on the same period.
During the life of the product, the note price may drop below 100%.
The marked to market may not fluctuate in the same proportion as the
underlying: its price depends on a combination of forwards, volatility,
interest rates, time to maturity etc... Indeed, to benefit fully from the rise in
the spot price, the investor needs to carry the product to maturity.
For the avoidance of doubt, the evolution of the price of the note is
mainly based on the market value of the futures contracts
(corresponding to the maturity of the product). Furthermore, at the
beginning of the life of the product, the delta is small (i.e. a move
in the futures contracts will only have a small impact on the price
of the product). However, as time goes by, the delta may increase
and the move in the futures contract (above the strike) may have a
much greater impact. All things equal, this means that if the spot
price of each commodity moves on the upside but the futures
contracts do not move, the price of the note will not increase.
196
EXAMPLE 2 TERMS
This is Attractive!
Why this basket?
Nick Motson
33
EXAMPLE 2- HOW DO THEY PRODUCE SUCH
HI GH PARTI CI PATI ON?
There are 2 things going on here:
1. We know that the volatility of a basket is less
than the volatility of an individual commodity
But that isnt enough to get 150% participation
Nick Motson
2. There must be something special about the
basket
34
197
EXAMPLE 2- HOW DO THEY PRODUCE SUCH
HI GH PARTI CI PATI ON?
Most people who want to invest in commodities
think of Gold & Oil, but those 2 commodities only
make up 1/3 of the basket.
Nick Motson
The other 2/3 are made up of Nickel, Zinc &
Copper Why?
35
EXAMPLE 2- GOLD & OIL FORWARDS
(1/ 3 OF THE BASKET)
Nick Motson
36
198
EXAMPLE 2- ZINC, NICKEL & COPPER
FORWARDS (2/ 3 OF THE BASKET)
Nick Motson
37
EXAMPLE 3 - A YIELD PRODUCT
Nick Motson
38
199
01 December 2005 J.P. Morgan Securities Ltd.
Information herein reflects current market practices and is not intended to constitute legal, tax or accounting advice; clients should consult their own advisors on such matters. Additional information is
available on request. This document is being submitted to selected recipients only. It is provided on the basis that it may not be reproduced, in whole or in part, to any other person without the prior written
permission of JPMorgan. Although the information in this document has been prepared in good faith from sources which JPMorgan believes to be reliable we do not represent or warrant its accuracy and
such information may be incomplete or condensed. Opinions and estimates constitute our judgement and are subject to change without notice. This material is not intended as an offer or solicitation for the
purchase or sale of any financial instrument. Transactions should be executed through a JPMorgan entity qualified in the client's home jurisdiction unless governing law permits execution elsewhere. This
termsheet is not intended to provide the basis for any evaluation of the financial instruments discussed herein. In particular, information in this document regarding any new financial instruments should be
regarded as indicative, preliminary and for illustrative purposes only, and evaluation of any such financial instruments should be made solely on the basis of information contained in the relevant
confirmation when available. JPMorgan does not act as a fiduciary for or an advisor to any prospective purchaser of the financial instruments discussed herein and is not responsible for determining the
legality or suitability of an investment in the financial instruments by any prospective purchaser.
EUR 1 Year REVERSE CONVERTIBLE ON WTI CRUDE OIL FUTURES
INDICATIVETERMS ANDCONDITIONS
Instrument Type: Commodity Linked Reverse Convertible
Issuer: J.P. Morgan International Derivatives Ltd., Jersey
Guarantor: JPMorgan Chase Bank, N.A.
Rating of Guarantor: Aa2/AA-
Lead Manager: J.P. Morgan Securities Ltd., London
Documentation: J.P. Morgan International Derivatives Ltd. EMTN Programme
Underlying Commodity: The price per barrel of West Texas Intermediate light sweet crude oil on
the NYMEX of the futures contract specified below, as made public by
the NYMEX (Bloomberg: CL1 <Cmdty>)
Trade Date: 01 December 2005
Initial Fixing Date: 01 December 2005
Issue Date & Settlement Date: 22 December 2005
Final Fixing Date: 01 December 2006
Final Settlement Date: 22 December 2006
Commodity Business Day: A trading day on the NYMEX or a day that would have been a trading
day but for the occurrence of a Market Disruption
Denominated Currency: Euro (EUR)
Denomination: EUR 50,000 per Note
Notional Amount: EUR 6,000,000
Number of Notes: 120
Re-Offer Price: 99.30% (of Denomination)
Issue Price: 100% (of Denomination)
Coupon: 10% fixed coupon paid by JPMorgan on the Final Settlement Date
Strike Price: USD 58.47 (100% of WTI
I
)
Kick-In Strike: USD 40.3443 (69% of the Strike Price)
Kick-In Event: A Kick-In Event shall be deemed to occur if, on any Commodity
Business Day during the period from and including the Initial Fixing
Date to and including the Final Fixing Date, the closing price of the
Underlying Commodity on the Exchange trades at or below the Kick-In
Strike
J. P. Morgan Securities Ltd. is authorised by the Financial Services Authority in the United Kingdom. References herein to "JPMorgan" shall mean J. P. Morgan Chase & Co. or any of its affiliates or
subsidiaries including, but without limitation to the generality of the foregoing, J. P. Morgan Securities Ltd.
Redemption: Scenario 1:
If a Kick-in Event has not occurred before or on the Final Fixing Date,
each Instrument will be redeemed on the Maturity Date and the investor
will receive EUR 50,000 in cash per note
Scenario 2:
If a Kick-In Event has occurred before or on the Final Fixing Date, the
following redemption scenarios occur:
1) If, on the Final Fixing Date, the Underlying Commodity closes at the
Exchange at or above the Strike Price, each Instrument will be redeemed
on the Maturity Date and the investor will receive EUR 50,000 in cash
per Instrument
2) If, on the Final Fixing Date, the Underlying Commodity closes below
the Strike Price, each Instrument will be redeemed on the Maturity Date
and the investor will receive a cash settlement of a EUR amount per
Instrument equal to:
EUR 50,000 x [100% + Min (0%, WTI
F
/WTI
I
-1)] where:
WTI
I
is the at the money spot price per barrel on the Initial Fixing Date
of WTI on the NYMEX of the first contract for the future delivery of
such oil to expire after such date, stated in US dollars, as made public by
the NYMEX on that date (= 40.3443)
WTI
F
is the closing price per barrel on the Final Fixing Date of WTI on
the NYMEX of the first contract for the future delivery of such oil to
expire after such date, stated in US dollars, as made public by the
NYMEX on that date.
Exchange: NYMEX
Settlement of the Notes: Cash Settlement
Listing: No Listing
Governing Law: As per Programme
Sales Restrictions: UK, US
ISIN: XS0237709117
Ric Code: 023770911
Calculation Agent: J.P. Morgan Securities Ltd
Clearing System: Euroclear/Clearstream
Business Day Convention: Modified Following
Business Day Centres: Luxembourg, Netherlands, Belgium, London
200
Secondary Sales/Distribution by the Investor following purchase from JPMSL
1. The Investor represents and agrees that it will comply with all applicable laws and regulations in each jurisidiction in
which it (1) offers, sells or delivers the securities described in this term sheet (the Securities) or (2) has in its possession
or distributes any form of offering documentation or publicity material relating to the Securities, in all cases at its own
expense. It will also ensure that no responsibilities, obligations, liabilities, costs or claims are imposed on the Issuer, the
Guarantor or J. P. Morgan Securities Ltd. ("JPMSL") in any such jurisdiction as a result of any of the foregoing actions
by the Investor.
2. The Investor will ensure that the Issuer, the Guarantor and JPMSL will have no responsibility, liability or obligation for
any consent, approval or permission required by the Investor (whether or not obtained) or any actions taken (or not taken)
by the Investor for the offer, sale or delivery of the Securities under any laws and/or regulations in force in any jurisdiction
to which it is subject or in which it makes any offer, sale or delivery of the Securities.
3. The Investor is purchasing the Securities from JPMSL as principal and not as agent for third parties. If the Investor
distributes or subsequently resells the Securities to other investors the Investor will act as a principal and independent
distributor on a non-exclusive basis in respect of any such distribution or resale. Unless explicitly otherwise agreed in
writing, nothing in this termsheet shall create any partnership, joint venture, or relationship of principal and agent
between the Issuer, the Guarantor or JPMSL (or any of their affiliates or subsidiaries) and the Investor, or provide any
such party with any right, power, or authority, whether express or implied, to create any such duty or obligation on behalf
of any other party.
4. The Investor acknowledges that the purchase of the Securities involves certain risks and is suitable only for, and should
be made only by, investors that have such knowledge and experience in financial and business matters as may enable them
to evaluate the risks and merits of an investment in the Securities, and the Investor agrees that it shall be solely responsible
for ensuring that all subsequent purchasers of the Securities from it are eligible to purchase Securities under all applicable
laws, regulations ordinances and codes, under the restrictions and conditions applicable to the sale of the Securities as set
forth in the programme agreements relating to the Securities and in light of investor suitability considerations
5. The Investor shall ensure that each investor to whom it sells or distributes Securities (i) is duly informed of the risks
related to an investment in the Securities and (ii) receives sufficient information to make an informed decision whether to
invest in the Securities. Furthermore, the Investor shall ensure that the complexity and risks inherent in the Securities are
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For the purposes of this provision, the expression an "offer of securities to the public" in relation to any securities
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201
COMMODITY BARRIER
REVERSE CONVERTIBLE
This is a 1 year note,
paying a 10% coupon
COUPON PAYING BOND
SHORT
=
+
The down & in puts
must be valuable
Nick Motson
SHORT
DOWN & IN
PUT OPTION
39
Forward
Spot
Nick Motson
40
202
EXAMPLE 4
COMBINED YIELD & GROWTH PRODUCT
Nick Motson
41
203
Description: A 5 year USD denominated note paying a strip of annual fixed
coupons of 8.00% p.a.*, plus a USD amount at maturity equal to
the then prevailing Basket Price.
The Note is not principal protected.
Issuer:
Merrill Lynch S.A. , under its EMTN program
Guarantor:
Merrill Lynch & Co., Inc., Delaware (Aa3/AA-/A+)
ISIN: XS0255340266
Valor: 2567253
Trade Date: 16

May 2006
Issue Date:
06 June 2006
Valuation Date: 16 May 2011
Final Settlement Date: 06 June 2011
Issue Size:
2,000,000 (subject to increase)
Denomination:
USD 1,000
Currency:
USD
Issue Price:
100%
Annual Coupon*:
8.00% (30/360) p.a. payable ANNUALLY in arrears
Redemption:
u
i
i v
i
P
P
w
, 0
,

Pv,i:
Closing Level of Underlying i on the Valuation Date
P0,i: Closing Level of Underlying i on Trade Date
wi: Weight of Underlying i
Basket:
Contract
i Underlying wi
(Reference)
P0,i
Front Month contract LME Copper
1 LME Copper 25%
(Bloomberg: LP1 <Cmdty>)
8,435
Front Month contract LME Aluminium
2 LME Aluminium 25%
(Bloomberg: LA1 <Cmdty>)
2,964
3 US Nat Gas 25% December 11 NYMEX Nat Gas futures contract
Xs0255340
Income Note on Commodity Basket
5 year with 8.00% p.a. fixed coupon
COMMODITIES
Merrill Lynch
Commodity
Solutions
Merrill Lynch Commodity Solutions
2

(wsj.com: NYMEX Natural Gas Last Price)
10.456
Front month futures contract ICE Brent
4 Brent Crude 25%
(Bloomberg: CO1 <Cmdty>)
70.34

Listing:
London
EU/ Swiss savings
Tax:
TK code 14 (Out of scope)
Governing Law:
English
Calculation Agent:
Business Days:
London and New York

Disclaimer
*Subject to market conditions on Trade Date

This Term Sheet contains indicative terms only. All materials contained herein are for discussion purposes only. Finalised terms and conditions
are subject to further discussion and negotiation. The information included herein has certain inherent limitations, will be affected by any
structural changes and investors should not rely on this information in making their investment decisions. Merrill Lynch International will not
be responsible for the consequences of reliance upon any statement or information contained herein or any omission. We make no
representation and have given you no advice concerning the appropriate accounting treatment or possible tax consequences of this indicative
transaction.

This is not an offer to buy or sell or solicitation of an offer to buy or sell any security or instrument or to participate in any particular trading
strategy. The terms outlined herein are summary and indicative only and are subject to change. Any written offer of such security may be made
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for sale in the United States or to U.S. persons. This material may not be distributed in the United States.

We or our affiliates may buy or sell securities or have long or short positions in securities economically related to any security mentioned
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This communication is furnished at the request of the recipient for the exclusive purpose of identifying the nature of the security or other
instrument referred to herein. It is furnished for your private information with the express understanding, which recipient acknowledges, that
it does not constitute an offer of such security or a means by which such security may be offered or sold.
204
EXAMPLE 4- A FREE LUNCH?
So you receive:
1. An 8% per annum coupon (well above market
rate)
2. The return on the basket
How do you generate the return on the basket
(think back to lecture 5)?
Nick Motson
( )
42
EXAMPLE 4- NO FREE LUNCH!
To structure this not you buy a zero strike call on
the basket of commodities:
Copper Copper
Aluminium
Natural Gas
Brent Crude
ALL OF WHICH WERE IN BACKWARDATION!!!!
S th t ik ll t l t l th th
Nick Motson
So the zero strike call costs a lot less than the
spot prices and hence you have money left
over to provide the juicy coupon
43
205
EXAMPLE 5 - GOLD NOTE
WITH COUPON & 100% PARTICIPATION!
Nick Motson
44
206
Page 1 of 3
The terms outlined herein represent only a summary of the terms and conditions of the Notes which will be issued under the ML&Co. EMTN
Programme. The full terms and conditions for the Notes, which will be the only legally binding terms, will be contained in the Offering Circular
for the Programme dates 1 July 2005, and in the Final Terms or Securities Note (to be dated on the Issue Date). The Offering Circular and
Final Terms/Securities Note will be made available upon the issuance of the Notes.
.
Global Markets & Investment Banking Group
Structured Commodity Products
5Y USD 100% Capital Guaranteed Gold Linked Note
Final Indicative Terms and Conditions
Issuer: Merrill Lynch & Co., Inc under its EMTN Program (Aa3)
Dealer: Merrill Lynch International
Calculation Agent: Merrill Lynch International
Trade Date: 30 March 2006
Issue Date: 24 April 2006
Maturity Date: 26 April 2011
Underlying: Gold Ounce (Bloomberg: GOLDLNPM <Cmdty> Go)
Issue Price: 100%
Min Denomination: USD 1,000
Notional: USD 1,300,000 (Open for increase until 24 April 2006)
Coupon: 5.00%
Payment per USD 1,000 will be USD 50 at maturity
For Swiss tax purposes, this 5.00% payment is subject to income tax
Redemption at Maturity: 100% +

u
Initial
Initial Average
Gold
Gold Gold
Max , 0 % 100
GoldInitial: USD 580.00
Arithmetic quarterly average of the Underlying, observation dates:
30-Jun-06 Fri 28-Sep-07 Fri 30-Dec-08 Tue 31-Mar-10 Wed
29-Sep-06 Fri 28-Dec-07 Fri 31-Mar-09 Tue 30-Jun-10 Wed
28-Dec-06 Thu 31-Mar-08 Mon 30-Jun-09 Tue 30-Sep-10 Thu
30-Mar-07 Fri 30-Jun-08 Mon 30-Sep-09 Wed 30-Dec-10 Thu
GoldAverage:
29-Jun-07 Fri 30-Sep-08 Tue 30-Dec-09 Wed 31-Mar-11 Thu
Secondary Market: Under normal market conditions, Merrill Lynch International will
make a daily secondary market in the Notes with a bid-ask spread
no larger than 1%
Selling Restrictions: US, European Economic Area, UK
Governing Law: New York Law
Listing: None
Business Day: London, Target Settlement Day
Clearing: Euroclear / Clearstream
Valor 2511294
ISIN XS0250528899
Reuters TBA
Bloomberg TBA
Page 2 of 3
The terms outlined herein represent only a summary of the terms and conditions of the Notes which will be issued under the ML&Co. EMTN
Programme. The full terms and conditions for the Notes, which will be the only legally binding terms, will be contained in the Offering Circular
for the Programme dates 1 July 2005, and in the Final Terms or Securities Note (to be dated on the Issue Date). The Offering Circular and
Final Terms/Securities Note will be made available upon the issuance of the Notes.
.
Global Markets & Investment Banking Group
Structured
Solutions Group
+442079965369
MartinKummer
martin_kummer@ml.com
207
EXAMPLE 5
THE OPTI ON I S ASI AN
Nick Motson
45
COMMODITY LINKED NOTES
As with equity linked notes two of the key
drivers of pricing/structuring are
Interest Rates
Implied Volatility
However for commodities the third factor that
Nick Motson
However for commodities the third factor that
has to be taken into consideration is the shape
of the forward curve
46
208
COMMODITY LINKED NOTES
If the forwards are in contango (forward
prices above spot price)
Calls ATMSpot will be ITMforward and hence Calls ATM Spot will be ITM forward and hence
expensive
Puts ATM Spot will be OTM forward and hence
cheap
If the forwards are in backwardation (forward
prices below spot price)
Calls ATMSpot will be OTMforward and hence
Nick Motson
Calls ATM Spot will be OTM forward and hence
cheap
Puts ATM Spot will be ITM forward and hence
expensive
47
HOMEWORK THIS WEEK
Compulsory
Read The Tactical and Strategic Value of Commodity Futures by
Erb & Harvey (available here on SSRN)
htt / / / l3/ f ? b t t id 650923 http:/ / papers.ssrn.com/ sol3/ papers.cfm?abstract_id=650923
Answer the following questions:
i. Should investors consider diversifying their portfolios by holding
commodity indices
ii. Will the excess return of the GSCI be as high as spot return in the
current environment?
iii. Can you think of a way to improve the expected return on an
index such as GSCI?
Nick Motson
index such as GSCI?
Optional
Pages 187-205
48
209
Lecture 7
Interest Rate Products
Nick Motson
1
I guess I should warn you, if I turn out to be particularly clear,
you've probably misunderstood what I've said. Alan Greenspan
210
BONDS
A BRIEF REVISION
Nick Motson
2
FIXED RATE BONDS
Redemption at
Par + Coupon
Fixed Periodic
Coupons
Bond is sensitive to:
Market rates
rates up = price down
Purchase
Nick Motson
Credit of issuer
credit spread up =price down
3
Purchase
Price
211
FLOATING RATE NOTES
Redemption at
Par + Coupon
Floating Periodic
Coupons
FRN is NOT sensitive to:
Market rates
rates up = coupon up = price almost unchanged
Purchase
Nick Motson
FRN IS sensitive to:
Credit of issuer
credit spread up =price down
4
Purchase
Price
INTEREST RATE SWAPS
A BRIEF REVISION
Nick Motson
5
212
MECHANICS
An Interest Rate Swap (IRS) is an exchange of interest
payments, where one party has fixed interest payments
and the other party has floating interest payments p y g p y
based on a reference rate (Libor, Euribor etc.)
FIXED
RATE
Fixed Rate
x
Notional Principal
FIXED
RATE
Nick Motson
PAYER RECEIVER
Floating Rate
x
Notional Principal
6
MECHANICS
Flows for a 2 year annual fixed versus 6 month
floating swap
FLOATING
0
FLOATING
RATE
FIXED
6m 12m 18m 24m
Nick Motson
An IRS does not involve any exchange of capital,
only interest rate cash flows are exchanged.
RATE
7
213
MECHANICS
An IRS is an OTC transaction & so the following
terms must be agreed
Notional amount Notional amount
Maturity
Payer/receiver
Start date, fixing dates, payment dates
Fixed rate: level, basis, frequency
Floating rate: level (first fixing), reference, frequency
Stub period (at the end, at the beginning)
Nick Motson
Stub period (at the end, at the beginning)
Date conventions
8
MECHANICS
There are standardised conventions and this is
an extremely liquid market.
However swaps can be tailor made
Quotation
Fixed rate
Spread over floating reference
Upfront payment (Greece & Goldman)
Nick Motson
Upfront payment (Greece & Goldman)
Combination of all three
9
214
MECHANICS
Traditionally IRS were traded interbank via the telephone but now
much of the trading is done electronically
Nick Motson
10
YIELD CURVES
In order to for two counterparties to enter into
an IRS the NPV at time zero must equal zero
NPV FIXED LEG = NPV FLOATING LEG
This means that the fixed rate must contain the
market prediction of future floating rates.
Nick Motson
Using a technique called bootstrapping the
implied forward rates can be calculated.
11
215
YIELD CURVES
If you have ever opened a finance text book, yield
curves always look like this
Y
i
e
l
d
Nick Motson
12
What does this shape imply for the forward rates?
Maturity
YIELD CURVES
The current
USD yield
curve is curve is
upward sloping
very much like
the text book
example
Nick Motson
13
216
YIELD CURVES
This implies
that the
forward rates
are also are also
upward sloping
BUT at a faster
rate
At present the
curve is
predicting US
rates rising to
Nick Motson
14
3% over the
next 6-7 years
YIELD CURVES
THE CURVE
I S NOT
ALWAYS THE
SHAPE SHAPE
SHOWN I N
THE
TEXTBOOKS!
This is what
the USD curve
looked like in
Nick Motson
15
mid 2007
217
YIELD CURVES
THE CURVE
I S NOT
ALWAYS THE
SHAPE SHAPE
SHOWN I N
THE
TEXTBOOKS!
This is what
the GBP curve
looked like
Nick Motson
16
1992
USING SWAPS
IN INVESTMENTS
Nick Motson
17
218
ASSET SWAPS
Suppose you want to buy some bonds
You really like Warren Buffet
BUT
You think interest rates might rise
What can you do?
Nick Motson
What can you do?
18
ASSET SWAPS
You have
identified a
Berkshire Berkshire
Hathaway
bond with a
6.5 year
maturity which
pays a 5.4%
coupon and is
currently
offered for
Nick Motson
19
sale at a price
of 116.129
219
ASSET SWAPS
Hopefully it is
not a surprise
to you that to you that
because the
price is above
par the yield to
maturity is
below 5.40%
For every 1bp
Nick Motson
20
that yields rise
this bond will
fall in value by
0.06416
ASSET SWAPS
You think that yield might rise so buying a
fixed rate bond is not a very sensible
thing to do.........
You want an FRN but you cant find a
Berkshire Hathaway FRN so what you
need to do is a swap!
Nick Motson
need to do is a swap!
21
220
ASSET SWAPS
You could take
the 2.70%
semi-annual semi annual
fixed coupon
you will receive
every six
months from
the bond and
swap it for a
floating coupon
By entering
Nick Motson
22
into an I RS (or
asset swap)
ASSET SWAPS
I f you enter
into the asset
swapyou will swap you will
receive
USD LI BOR
+ 110.5bp
you still have
the exposure to
Warren Buffet
that you
wanted BUT
Nick Motson
23
you will have
hedged the
interest rate
risk.
221
ASSET SWAPS
Obviously this can be done the other way
round
Turning an FRN into a fixed rate bond
Or an issuer can choose to issue an FRN
when there is demand & use an IRS to
convert this into fixed rate debt or vice-
Nick Motson
convert this into fixed rate debt or vice
versa.
24
STEP UP NOTE EXAMPLE
This is an
example of a SG
product from
2010.
GBP example:
Market Rates
6 Month Libor
0.84688%
3 Year Swap
Nick Motson
3 Year Swap
2.51%
Too good to be
true?
25
222
You will recall from
slide 11 that we can
use a technique
called bootstrapping,
i th k t
Term Date
Market
Rate
Price
Source
Discount
Factor
1d 20-Jan-10 0.51% Cash Rate 1.0000
1w 26-Jan-10 0 51% Cash Rate 0 9999
using the market
rates to calculate
discount factors
(Bloomberg can do
this for you)
Now we have
discount factors we
1w 26 Jan 10 0.51% Cash Rate 0.9999
1m 19-Feb-10 0.52% Cash Rate 0.9996
2 month 19-Mar-10 0.55% Cash Rate 0.9991
3 month 19-Apr-10 0.61% Cash Rate 0.9985
4 month 19-May-10 0.69% Cash Rate 0.9977
5month 21-Jun-10 0.77% Cash Rate 0.9968
6 month 19-Jul-10 0.85% Cash Rate 0.9958
1 year 19-Jan-11 1.13% Cash Rate 0.9888
2 year 19-Jan-12 1 88% SwapRate 0 9631
Nick Motson
discount factors we
can calculate the NPV
of the cash flows
2 year 19-Jan-12 1.88% Swap Rate 0.9631
3 year 21-Jan-13 2.51% Swap Rate 0.9270
26
Obviously it isnt too
good to be true
because the NPV is
slightly negative
Terms
Investment 100
Coupon Year 1 2.00%
(this is the profit for
the issuer)
The investor is
receiving a fair rate
BUT it is the timing of
the cash flows that
makeit look
p
Coupon Year 2 2.40%
Coupon Year 3 2.80%
Term Date Principal Coupon
Total
Cashflow
Discount
Factor
Present
Value
Today 19-Jan-10 -100 -100.0 1 -100.00
6 month 19-Jul-10 1.0 1.0 0.995818 0.9958
1 year 19-Jan-11 1.0 1.0 0.98881 0.9888
1.5 year 19-Jul-11 1.2 1.2 0.975957 1.1711
2 year 19-Jan-12 1.2 1.2 0.963103 1.1557
2.5 year 19-Jul-12 1.4 1.4 0.945069 1.3231
3 year 21 Jan 13 100 1 4 101 4 0 927035 94 001
Nick Motson
make it look
attractive
i.e. higher than Libor
now and rising in the
future
3 year 21-Jan-13 100 1.4 101.4 0.927035 94.001
-0.36 Total NPV
27
223
From the discount
factors we can imply
th k t t f
4.00%
4.50%
the market rates for
each of the coupon
dates.
The investor is
receiving a higher
than market rate for
coupons 1 & 2 but
then lower than
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
Nick Motson
then lower than
market rate for
coupons 3 to 6.
0.00%
0.50%
1 2 3 4 5 6
Market Coupons Step Up Note Coupons
28
INTEREST RATE OPTIONS
Nick Motson
29
224
INTRODUCTION
There are 2 main categories of interest
rate option:
Swaptions
These are options on an interest rate swap
Caps/Floors
These are options on a floating rate such as Libor.
Nick Motson
A cap is a guaranteed ceiling rate and a floor is a
guaranteed lowest rate
30
SWAPTIONS
Unlike the options we have covered so far, swaptions
are not called calls & puts, instead they are referred to
as payer and receiver swaptions as payer and receiver swaptions
A payer swaption gives the right to pay the fixed rate
and to receive the floating rate. The receiver swaption
gives the right to receive the fixed rate and pay the
floating rate.
Payer swaptions can be thought of as a call on the swap
Nick Motson
Payer swaptions can be thought of as a call on the swap
rate (you only want to exercise if the rate is higher)
Receiver swaptions can be thought of as a put on the swap
rate (you only want to exercise if the rate is lower)
31
225
SWAPTIONS
This is an example
of a 1y into 5y
receiver
swaption
It gives the right to
enter into a 5y
swap receiving
2.00% fixed
annually vs paying
3 month Libor in 1
years time
Nick Motson
32
The premium is
2.37792% of the
notional to be paid
upfront
SWAPTIONS
If in 1 years time the 5 year swap rate is higher than
2.00% then the option will expire worthless
HHowever
If in 1 years time the 5 year swap rate is lower than
2.00% then the option will be exercised. In this case
there are 2 possible ways of settling the transaction:-
1. Physical Settlement - The counterparties enter into a 5
year swap at 2.00%
Nick Motson
2. Cash Settlement The seller pays the buyer the NPV of a 5
year swap at a rate of 2.00% using current market rates for
discounting
33
226
SWAPTIONS
Because there
are many
ibl i possible option
maturities and
underlying swap
tenors a volatility
grid is used for
pricing.
Nick Motson
34
CAPS/ FLOORS
A cap is a guaranteed ceiling rate for a floating-
rate.
It ensures that the interest rate does not exceed the
strike price. This guarantee is effective for every period
or fixing
A cap is a series of simple options on each fixing, called caplets.
Nick Motson
35
227
CAPS/ FLOORS
This is an example of a
3y 5.2% GBP cap
At each libor fixing
d t date:
I f 3m libor < 5.20%
No exchange
I f 3m libor > 5.20%
The buyer receives
10m x (libor 5.2%)
x number of days/365
Nick Motson
36
x number of days/365
For this protection the
buyer pays 48.4bp
upfront
CAPS/ FLOORS
CAP - Profit/Loss Graph for each 3-month
period
GBP Libor
Profit
5.20%
G
B
P

L
i
b
o
r

5
.
2
0
Premium
Nick Motson
Hopefully this looks familiar!!!!!!!!!!!!!!!!!!
37
0
%
228
CAPS/ FLOORS
Floor - Profit/Loss Graph for each 3-month
period
GBP Libor
Profit
Strike
S
t
r
i
k
e

-
G
B
P

L
i
b
Premium
Nick Motson
38
b
o
r

CAPS/ FLOORS
A cap is simply a collection of successive
caplets, in our 3 year GBP 3 month cap example
there will be 9 individual caplets
Caps/Floors can also be exotic in just the same
way we have seen for equity options e.g.
Digital Caps/Floors
Knock-in Caps/Floors
Nick Motson
Knock-out Caps/Floors
The payoffs of these will be the same as you
have seen before
39
229
USING SWAPS & OPTIONS
IN INVESTMENTS
Nick Motson
40
STEP UP NOTE WITH CAP & FLOOR
EXAMPLE
This is another
example of a SG
product from
2010.
GBP example:
The investor
receives 3
month GBP Libor
with a minimum
of 1 25% anda
Nick Motson
of 1.25% and a
maximum of
5.20%
How do they
structure this?
41
230
EXAMPLE
This structure is made up of 3 components:
1. Buying an FRN To provide the Libor return
2. Buying a floor with a 1.25% strike to guarantee the
minimum return
3. Selling a cap with a 5.20% strike which caps the
return (we know that this is worth 48.4bp)
Nick Motson
42
EXAMPLE
The 1.25% floor
is worth 72.5bp
So if we sell the
cap for 48.4bp
we still have to
find 24.1bp from
somewhere........
Nick Motson
43
231
EXAMPLE
Where could the 24.2bp come from?
The clue is in the issuer The clue is in the issuer
An A+ rated issuer will have to pay above Libor
for funds, 24.1bp upfront is approximately 8bp
Nick Motson
per annum.....
44
INVERSE FLOATERS
An inverse floater, as its name
suggests pays a coupon that
varies with the inverse of the
ffloating rate.
The coupon will be paid
according to the formula
X% minus floating rate
Nick Motson
How do they structure this?
(I am not going to cover the MXN example as I dont
have access to the required data)
45
232
INVERSE FLOATERS
Suppose an investor has the view that UK interest rates will remain low and
hence requests a 5-year GBP inverse floater.
How can we structure this & what coupon can be paid? o ca e st uctu e t s & at coupo ca be pa d
Does drawing it help?
Fixed Periodic
Coupons
Redemption at
Par + Coupon
Nick Motson
Purchase
Price (par)
Floating Periodic
Coupons (Libor)
46
INVERSE FLOATERS
Step 1:
Buy an FRN (assume pays Libor)
Floating Periodic
Redemption at
Par + Coupon
Floating Periodic
Coupons
Nick Motson
OK we solved the problem of the purchase & redemption BUT the floating
coupons are the wrong way round & we have no fixed rate coupons........
Purchase
Price (par)
47
233
INVERSE FLOATERS
Step 2:
Receive fixed/Pay floating IRS on twice the par amount
Fixed Periodic Coupons (2 x swap rate)
Nick Motson
Floating Periodic Coupons (2 x Libor)
48
INVERSE FLOATERS
The market
price for a
GGBP 5 year
quarterly
fixed vs 3
month libor
swap is
1.386%
Nick Motson
49
234
INVERSE FLOATERS
Adding together steps 1 & 2 almost gets us
there:
Pay par at beginning & receive par at the end
On each payment date
Receive 2 x the swap rate (1.386% x 2 = 2.772%)
+ Pay 2 x Libor (on the swap)
+ Receive Libor (from the FRN)
Nick Motson
+ Receive Libor (from the FRN)
= Receive 2.772% Libor
There is just one step remaining...........
50
INVERSE FLOATERS
What would happen if 3 month Libor set at greater
2.772% on one of the coupon dates?
Would the investor pay the issuer?
NO! The coupon has a floor of zero
How do we achieve this?
Nick Motson
51
235
INVERSE FLOATERS
Need to buy a
5 year
2 772% cap! 2.772% cap!
This costs
103bp
upfront
OR
21.429 bpper
annum
Nick Motson
So we deduct
this from the
coupon
52
INVERSE FLOATERS
So now we Receive:
(2.5577% Libor) (2.5577% Libor)
BUT Our cap is struck at 2.772%...........
So we will need to move down the strike of our cap, which will make it
more expensive, which will reduce our coupon......
Nick Motson
more expensive, which will reduce our coupon......
more expensive, which will reduce our coupon.......
Etc. Etc. Etc. Etc. Etc. until it converges........
53
236
INVERSE FLOATERS
INVERSE FLOATER
(X- Libor)
=
Long FRN
Receive Fixed IRS
(2 x par amount)
=
+
+
Nick Motson
54
Long Cap
+
INVERSE FLOATERS
The duration of an inverse floater is longer than a fixed rate
bond of the same maturity (very sensitive to interest rate
changes)
When rates fall, the inverse floater will rapidly increase
in value
Coupons Higher
Present value of future cash flow Higher
BUT
Whenrates increase the inverse floater takes double
Nick Motson
When rates increase, the inverse floater takes double
hit:
Coupons Lower
Present value of future cash flow Lower
55
237
RANGE ACCRUAL NOTES
A range accrual note pays a
coupon for every day that the
underlying index falls within a
defined range. de ed a ge
If the underlying index is outside
the range the coupon is zero.
These notes provide investors with
an above market coupon, but they
take the risk of foregoing coupon
t h LIBOR f ll
Nick Motson
payments when LIBOR falls
outside the range.
How do they structure this?
56
RANGE ACCRUAL NOTES
Does drawing the payoff help?
C
o
The buyer of this note is selling a digital cap and a digital floor with
t ik t th & fl t ti l f d
Libor
o
u
p
o
n
C
a
p
F
l
o
o
r
Nick Motson
strikes at the cap & floor rates respectively for every day.
The premium from selling these options is what provide the coupon.
The payoff from the short options has to equal the coupon so there
is a certain circularity in the pricing.........
57
238
RANGE ACCRUAL NOTES
Because of this
circularity we
have to rely on a
system such as
Bloomberg for
pricing.
In this example
we see that a 10
year USD range
accrual note with
a 0%-2.5%
Nick Motson
range pays
3.2348% this
compares to a 10
year market rate
of approx 2.16%
58
RANGE ACCRUAL NOTES
So we get a yield pick-up of over 100bp for a range
accrual note with a 0% to 2.5% range.
Is this a free lunch?
What is the risk?
Obviously if we go outside the range then the coupon
b
Nick Motson
becomes zero.......
59
239
RANGE ACCRUAL NOTES
Cast your mind
back to slide 14
It looks like the
0% digital floors
you are selling will
have very little
value
BUT
From 6 years
onward the 2.5%
digital caps look
like they could be
Nick Motson
60
like they could be
very valuable &
there is a good
chance of
receiving NO
coupon for a while
RANGE ACCRUAL NOTES
Range accrual notes tend to be popular when the
yield curve is very steep (like it is currently)
Higher coupons are available when the curve is steep
The buyer of the note is selling digital caps which will have lots
of intrinsic value further out on the curve if it is steep
The buyer is effectively betting against the curve and assuming
rates will be more stable than implied
Nick Motson
Another way to boost the coupon is to make the
whole note callable at par on each coupon date
61
240
RANGE ACCRUAL NOTES
For the same
range 0-2.5% a
callable structure callable structure
will pay a coupon
of 5.75%!!!!!!
An improvement
of 250bp what is
the catch?
If it looks like
Nick Motson
If it looks like
you will get your
coupon it will be
called, if you are
getting zero it
wont....
62
SUMMARY OF FIXED INCOME STRATEGIES
INTEREST RATE VIEW INVESMENT STRATEGY
L I t t R t B Fi dR t B d Lower I nterest Rates Buy Fixed Rate Bonds
Lower Interest Rates
(aggressive)
Buy Inverse Floating
Rate Bonds
Higher Interest Rate Buy Floating Rate Bonds
MSc Investment Management
Nick Motson
Stable Interest Rates Buy Range Accrual
Bonds
241
HOMEWORK THIS WEEK
Compulsory
Hull, Options, Futures & Other Derivatives, Chapter 8 Swaps
N Y Ti A ti l M k t Pl I O C t St t i N.Y. Times Article Market Place; In Orange County, Strategies
Sour available here
http://www.nytimes.com/1994/12/05/business/market-place-in-
orange-county-strategies-sour.html
Philippe Jorions Orange County Case,
available here http://merage.uci.edu/~jorion/oc/case.html
Optional
Nick Motson
Optional
Pages 168-167
64
242
Lecture 8
d i k d d FX & Fund Linked Products
Nick Motson
1
Markets are never wrong, opinions often are ..." J esse Livermoore
243
FX LINKED PRODUCTS
Nick Motson
2
INTRODUCTION
The FX market is probably one of the most
liquid in the world
Nick Motson
3
244
INTRODUCTION
Foreign exchange has developed into an asset
class over the past decade. This is largely due
to its low correlation with other asset classes to its low correlation with other asset classes.
At the same time structured product linked to
FX have increased in popularity, this is helped
by the fact that the FX options market is
extremely liquid with both vanilla & exotic
Nick Motson
extremely liquid with both vanilla & exotic
options quoted on many currency pairs across a
range of maturities.
4
FX OPTION QUOTING/ PRICING
Nick Motson
5
245
For vanilla option traders quote & trade implied
volatility rather than premium
O th t d h b d i d t ttl th Once the trade has been agreed in order to settle the
transaction they then calculate the premium using Black-
Scholes
Have to agree a spot level which can cause problems
E.g. Buyer of a call will want to set the spot level low (lower
premium) but the seller will want to set it high
Can agree to exchange delta which should make them
indifferent to the spot level
Nick Motson
indifferent to the spot level
Rationale is that spot is very volatile, where as
volatility is less so, hence dont need to
updating prices as often
6
In the above example we are looking at
USD/JPY
USD is the base currency (it comes first) so we are saying USD is the base currency (it comes first) so we are saying
how many JPY you get for one USD. As the price rises, the
base currency (USD) is strengthening & the counter
currency (JPY) is weakening
A USD Call gives you the right to buy USD, but
if you do this then you will also be selling JPY
Nick Motson
A USD CALL is also a J PY PUT
7
246
FX OPTIONS VOLATILITY SURFACE
Nick Motson
8
The above chart of the USD/JPY volatility
surface might look like Greek to you, it is!
5C is a 5% delta call i e A low delta USD call/JPY put this is 5C is a 5% delta call i.e. A low delta USD call/JPY put, this is
a high strike
5P is a 5% delta put i.e. A low delta USD put/JPY call, this is
a low strike
A Put & A Call with the same strike MUST have
the same volatility (put/call parity) so a low
Nick Motson
the same volatility (put/call parity) so a low
delta call is the same as a high delta put but the
way it is shown is just market convention.
9
247
It would appear that the volatility skew is such
that implied volatility is higher for puts than for
calls calls
This means that vol is higher for low strikes
Remember from week 3 this skew is because
the distribution is not log-normal
In this case fatter tail with USD/JPY lower
Nick Motson
NOT ONLY IS THE VOLATILITY STOCHASTIC,
SO IS THE SKEW
10
FX STRUCTURED PRODUCTS
In contrast to equity linked products, many FX
products are short dated
Shorter dated products (up to 1-year) are often
structured as deposits. These are simply bank
deposits with coupon(s) dependent on some
conditions.
Longer dates products (> 1-year) are generally
Nick Motson
g p ( y ) g y
structured as notes (generally MTNs like equity
products)
11
248
DUAL CURRENCY DEPOSITS
The most common FX linked structured product
is the Dual Currency Deposit (DCD)
Nick Motson
12
249

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253
Nick Motson
13
In November 2007 the 1-month JPY deposit
rate was approximately 0.5%, this deposit is
offering a rate of 8 60% which sounds very offering a rate of 8.60% which sounds very
attractive
To boost the coupon must be selling options
Whats the risk?
If JPY strengthens versus the USD then you get your money
back in USD rather than JPY (which is bad because the USD
t h k d)
Nick Motson
must have weakened)
14
254
You are selling a
1-month
JPY Call/USD Put /
with a 111 strike
The price for this
is approx 1.18%
So how do they
k th
Nick Motson
15
make the
coupon so high?
The 8.6% rate paid on the 1-month deposit is
an annual rate
O JPY 100 ld i On JPY 100 you would receive
100 x 8.6% x 30/360 = 0.71 (or 0.71%)
A traditional deposit would have paid 0.5%
On JPY 100 you would receive
100 x 0.5% x 30/360 = 0.04 (or 0.04%)
Nick Motson
So HSBC are paying you 0.67% for an
option that is worth 1.18%
16
255
If HSBC werent taking any spread (profit) they
could theoretically have offered a much higher
headline rate headline rate.
Approximately:
0.50%+ 1.1848% x (360/30) = 14.72%
Nick Motson
17
Deposit
Rate
Option Premium Annualised
Just in case you
dont believe me.
Bloomberg will
price Dual
Currency
Deposits for you
And is slightly
t !
Nick Motson
18
more accurate!
256
Dual Currency Deposits are generally offered for
shorter maturities
Thi i b th h dli i t t t l This is because the headline interest rates always
look more attractive
Although longer dated options are worth more, it is not
enough to make up for the compounding effect
Nick Motson
19
1-month 14.85%
3 th 9 15%
Nick Motson
20
3-month 9.15%
6-month 6.91%
1-year 5.61%
Clients would probably choose the 1-week paying 18.80%..........
257
As we have seen with equity linked products
(reverse convertibles) the DCD could be
structured to provide more protection by either structured to provide more protection by either
Moving the strike price
by selling a knock-in call or put
B th f th h ld b i l l
Nick Motson
Both of these approaches would obviously lower
the coupon but it depends on the risk appetite
of the investor.
21
PARTI CI PATI ON NOTES
Just as we saw with equity linked products
there are a host of growth products linked to
currencies and they are structured in exactly currencies and they are structured in exactly
the same way.
There are 2 main differences:
They tend to be shorter dated (1-2 years) this is
mainly because FX implied volatility is generally
lower than equity implied volatility so the options are
Nick Motson
o e t a equ ty p ed o at ty so t e opt o s a e
cheaper
Both Bullish & Bearish products are offered, where as
for equities generally they are all bullish
22
258
Nick Motson
23
259
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263
130
Pri nci pal Protected Currency Li nked Note
This just a zero
90
100
110
120
R
e
d
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m
p
t
i
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n

P
r
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c
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s
This just a zero
coupon bond & a
USD Call/JPY Put
Exactly the same
as we saw in
equity linked
products
Nick Motson
24
80
80.72 85.72 90.72 95.72 100.72 105.72 110.72 115.72 120.72 125.72 130.72
USD/JPY Spot Rate
Redemption Proceeds
The Difference is
how cheap the
option is p
2.76% premium
for a 2 year USD
Call that is
At The Money
Spot
Nick Motson
25
Why is the
option cheap?
2 Reasons.....
264
Why is the option cheap?
The implied volatility is only 9% this is MUCH lower
than equity volatility than equity volatility
Though the option is at the money spot what is the
delta?
33.52%, so it is out of the money, why?
Nick Motson
26
As we have seen with equity linked products if
the option is too expensive there are various
ways to cheapen it ways to cheapen it
baskets
Knock-in/knock out features
Digital options
Asian options
Nick Motson
All of these can and are used to enhance the
participation rate
27
265
EXOTIC EXAMPLE
Nick Motson
28
266

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Exchange Rate
270
EXOTIC EXAMPLE
This structure 109
110
1 YEAR FX-Li nked Bi nary Range Deposi t Notes
Li nked to USD-CAD Exchange Rate
should look
familiar to
you
IF you did
your
homework
f l
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
R
e
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e
m
p
t
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n

P
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c
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e
d
s
Nick Motson
29
after lecture
4!
90
91
0.77 0.81 0.85 0.89 0.93 0.97 1.01 1.05 1.09 1.13 1.17 1.21 1.25
USD/CAD Spot Rate
Barrier Touched Barriers Not Touched
EXOTIC EXAMPLE
This looks just like the scoop
Easiest way to structure is a double-knockout digital
call option with strike at the lower barrier &
knockouts at the upper & lower barriers.
Nick Motson
30
271
EXOTIC EXAMPLE
Here we
can see that
for a payoff
of 8 you
have to pay
2.
With
interest
rates at just
over 3%
thi l
Nick Motson
this leaves
enough for
a little
profit.....
31
EXOTIC EXAMPLE
Nick Motson
32
272
FUND LINKED PRODUCTS
Nick Motson
33
INTRODUCTION
Structured products on funds (traditional or
hedge funds) have become more popular in the
l t f f 2 i last few years for 2 main reasons:
1.
Nick Motson
2.
34
273
INTRODUCTION
However structuring products on funds
introduces specific problems that we have not
f iti diti i t t t seen for equities, commodities, interest rate or
FX products
1. NO liquid options market on the underlying
2 Restrictions on the liquidity of the underlying
Nick Motson
2. Restrictions on the liquidity of the underlying
(lock-up & redemption)
35
STRUCTURI NG
The attractiveness of fund linked products stems from the
capital guarantee element. In all of the capital guarantee
products we have seen so far, this guarantee is achieved by
the purchase of a zero coupon bond & the participation is
achieved by the purchase of a call option. However, for
fund linked products there are 3 possible structures:
Static guarantee with fund exposure
Static guarantee with call option exposure
Nick Motson
36
g p p
Vanilla dynamic guarantee (CPPI)
274
Structure Overview
Investor purchases Medium Term
Note (MTN)
I ll t X% f th i
STATIC GUARANTEE WITH FUND EXPOSURE
Investor Investor
Issuer allocates X% of the issuance
proceeds to Zero Coupon Notes priced
to mature at Par
100% Issue price less X% ZCN is
allocated/committed to the Fund
Component (or risky asset)
Investor receives 100% + value of the
Fund Component at maturity
Issuer Issuer
Cash
100% - X% X%
Notes
Nick Motson
37
Guarantee
Component
Guarantee
Component
Fund
Component
Fund
Component
ADVANTAGES
Cost effective guaranteed
STATIC GUARANTEE WITH FUND EXPOSURE
DISADVANTAGES
Participation rate dependent upon
g
structure for illiquid or hard to
mark assets
Certainty of payout (compared to
dynamic structures)
Path-independent
Interest rate
Maturity
Participation <100%
Nick Motson
38
275
Investor Investor
Structure Overview
Investor purchases Medium Term
Note (MTN)
I ll t X% f th i
STATIC GUARANTEE WITH CALL OPTION EXPOSURE
Issuer Issuer
Cash
100% - X% X%
Notes
Issuer allocates X% of the issuance
proceeds to Zero Coupon Notes priced
to mature at Par
100% Issue price less X% ZCN is
used to purchase Call Options on the
risky asset
Investor receives 100% + value of the
Nick Motson
39
Guarantee
Component
Guarantee
Component
Call
Option
Call
Option
ADVANTAGES
Higher (geared) exposure to risky
STATIC GUARANTEE WITH CALL OPTION EXPOSURE
DISADVANTAGES
Option difficult to price g (g ) p y
assets than static guarantee with
fund exposure
Certainty of payout (compared to
dynamic structures)
Path-independent
p p
Volatility?
Liquidity?
Participation rate dependent upon
Interest rate
Maturity
Cost of Option
Nick Motson
40
276
Structure Overview
Investor purchases Medium Term Note
(MTN)
I l C t t P ti
DYNAMIC GUARANTEE (CPPI)
Investor Investor
Issuer employs Constant Proportion
Portfolio Insurance (CPPI) technique to
allocate Notes issuance proceeds amongst
the three components that typically
comprise the CPPI Index:
The Fund Component (FC) consists of a notional
investment in the risky assets
The Cash Component (CC) consists of a notional
loan extended by the Issuer to provide leveraged
Issuer Issuer
Cash
Fund
Component
(FC)
Fund
Component
(FC)
Cash
Component
(CC)
Cash
Component
(CC)
Notes
Nick Motson
41
exposure to the FC or a cash deposit (e.g. when de-
leverage has occurred)
The Bond Component (BC) consists of a notional
investment in Zero Coupon Notes to ensure that in a
cash-out event a minimum of 100% is repaid at
maturity
(FC) (FC) (CC) (CC)
Bond
Component
(BC)
Bond
Component
(BC)
Participation = Min {Cap , (Equity Gap x Multiplier)}
Where: Where:
Equity Gap is the gap between the CPPI Index and the
price of the implied bond floor (price of zero coupon bond)
Multiplier is fixed at the outset (e.g. 5)
Capis the leverage cap (e g 200%) this is dependant on
Nick Motson
42
Cap is the leverage cap (e.g. 200%), this is dependant on
the volatility of the underlying investments
277
EXAMPLE
A new 7 year product with interest rates at 5% A new 7 year product with interest rates at 5%
Cap=200% & Multiplier=5.
Implied Bond Floor = e
-5% x 7
= 70.47%
Equity Gap = 1 - 70.47% = 29.53%
Participation =Min {200% , (29.53% x 5)} = 148%
Nick Motson
43
As the value of the underlying fund varies (and interest
rates & time) then the portfolio will be rebalanced
What we hope will happen
If the underlying fund NAV
rises steadily
200%
Note NAV
Fund NAV
rises steadily
the equity gap will increase
participation will rise
(subject to the cap)
The note will outperform the
100%
Protected Amount
Implied
Bond Floor
NAV
Equity Gap At Inception
Equity Gap At year 3
Nick Motson
44
p
fund due to the leverage
Time
(in Years)
0%
0 1 2 3 4 5 6 7
Maturity
278
What Could Happen
If the underlying fund NAV
falls (especially in the early
Fund NAV
falls (especially in the early
days)
the equity gap will decrease
participation will fall
All of the cash will end up
Note NAV
100%
Implied
Bond Floor
Fund NAV
NAV
Equity Gap
Nick Motson
45
p
invested in the bond
component with no further
participation (the structure is
monetized
Sample simulation Time
(in Years)
0%
0 1 2 3 4 5 6 7
Maturity
ADVANTAGES
Controlled leverage: typically
DISADVANTAGES
Should the Fund NAV decline g yp y
more than 100% of the Notes
issuance proceeds are invested in
FC at inception
CPPI rewards good performance:
embedded dynamic Leverage can
help boost the Note NAV to out
perform the Fund NAV
sharply, a full allocation to BC may
occur and the investor will not
benefit from any recovery in the
fund.
Interest Rates affect structure
over the whole lifetime not just at
Nick Motson
46
Soft landing: should Note NAV
decline, exposure to the risky
asset is reduced via the CPPIs de-
leveraging strategy
inception
279
EXAMPLE 1
Nick Motson
47
280
Issuer BNP PARIBAS
Rating AA- (S&P) / Aa3 (Moody's)
Dealer BNP PARIBAS UK Limited
Issue Type Euro Medium Term Note (EMTN)
Currency Euro (EUR)
Denominations EUR 100'000.-
Trade Date 16th February 2001
Issue Date 23rd February 2001
Maturity Date 23rd February 2006
Issue Price 100%
Coupon 0%
Underlying Fund
The ACE Euro Fund Ltd (the "feeder") is fully invested in shares of the US Dollar Class B
Participating Shares of the ACE Ltd (Aggressive Capital Enhancement) Fund and systematically
hedges the USD against Euro currency risk. ACE Ltd is a Fund of Hedge Funds managed by
Banque Syz & Co. or one of its affiliates
Redemption Price Each denomination will be redeemed at Maturity Date according to the following
formula
Redemption Amount per Denomination EUR 100'000.- x [100% + 77% x (NAV
final
- NAV
initial
)/NAV
initial
]
where:
NAV Initial Net Asset Value per Share of ACE Euro Fund Ltd on 28th February 2001
NAV Final The arithmetic average of the Net Asset Value per Share of the ACE Euro Fund Ltd on the 31st
March 2005, 30th June 2005, 30th September 2005 and 31st December 2005
Minimum Redemption Price EUR 100'000.-
Valuation Weekly (indicative)
Liquidation Monthly
Business Days Convention Following
Business Days for Payments Target
Calculation Agent BNP Paribas Arbitrage
Status of Notes Senior, Unsecured
Form of the Notes Permanent Global Note
Documentation Issuer's EMTN Documentation
Listing Luxembourg
Settlement Clearstream, Euroclear
ISIN Code XS 0124758029
Common Code 12475802
Secondary Market BNP Paribas Arbitrage will ensure the secondary market on this EMTN on a monthly basis with a
35-day prior notice.
INFORMATION
Banque Syz & Co. Geneva: +41 22 819 0909
BNP Paribas Paris: +33 1 40 14 69 89
a final expression of the terms and conditions of any security and it may be amended, superseded or replaced in its entirety by subsequent term sheets or other summaries and conditions.
This term sheet does not purport to identify or suggest all of the risks which may be associated with the proposed transaction
This term sheet is provided for discussion purposes only and it does not constitute either an offer to sell or the solicitation of an offer to buy any security. It is not intended to set forth
5-YEAR EMTN ACE II - 100% Capital Guaranteed
ACE Performance Linked Note
281
EXAMPLE 1
Looks like a Static Guarantee with Call Option Looks like a Static Guarantee with Call Option
structure
Not 100% Participation (expensive option)
Asian (average over last 4 quarters)
Nick Motson
48

EXAMPLE 2
Nick Motson
49
282
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288
EXAMPLE 2
Another Static Guarantee with Call Option structure Another Static Guarantee with Call Option structure
100% Participation
Very long maturity helps overcome the expensive
option problem
Nick Motson
50

EXAMPLE 3
Nick Motson
51
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303
EXAMPLE 3
This is quite clearly a CPPI structure
Nick Motson
52
EXAMPLE 3
How do you think this note has performed?
Nick Motson
53
304
HOMEWORK THIS WEEK
Compulsory
Attempt to answer the 2 attached sample exam questions (taken a
previous exam). Bring your answers to the next lecture.
Optional
Pages 151-168
Nick Motson
54
HOMEWORK THIS WEEK
QUESTI ON 1
Mr. J enkins is trustee for a charity that has received a 100m endowment from the National
Lottery. The charity is not allowed to spend any of the 100m capital but can use any income or
capital appreciation earned from the endowment to fund charity projects. Historically the charity
has invested all of its capital in bank bonds and deposits, but with interest rates at 0.75% this
l i ld 750 000 M J ki b li th t th h it ld i it now only yields 750,000 per annum. Mr. J enkins believes that the charity could increase its
income by investing in other asset classes such as equities; however this suggestion has been
rejected by board of trustees because it would put the 100m capital at risk.
Mr. J enkins seeks the advice of an investment bank as to how he can gain exposure to equities
without putting the capital at risk.
a) Assuming you work for the bank and under the above constraints, structure and discuss
the details and workings of 3 structured notes that will provide Mr. J enkins with exposure to
equities without risking his capital.
Support your answer with graphs and/or payoff formulas
(21 marks)
Nick Motson
b) Which of these 3 solutions would you recommend and why? Take into account different
elements, potential return, risk, etc.
(4 marks)
55
305
HOMEWORK THIS WEEK
QUESTI ON 2
Professor Roubini is not convinced by the recent stock market rally and thinks that over the next
12 months global stock markets will most likely drop by 10-15%. He has investigated the
possibility of buying vanilla S&P500 at-the-money put options in the listed options market, but p y y g y p p p ,
thinks that the price he has been quoted of 7.50% is too high given the profit potential.
A friend and former colleague from a nearby investment bank suggests that they might be able to
help with an OTC options contract. Since the bank has no credit lines for Professor Roubini, it will
not take any credit risk, i.e. the payoff to the investor at maturity should be zero or higher.
a) Assuming you work for the bank and under the above constraints, structure and discuss
the details and workings of 3 significantly different ways in which Professor Roubini can profit
from his view with an initial outlay which is less than the price of the vanilla put options.
Support your answer with graphs and/or payoff formulas
(21 marks)
Nick Motson
(21 marks)
b) Which of these 3 solutions would you recommend and why? Take into account different
elements, including price, downside risk, upside potential, etc.
(4 marks)
56
306

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DERI VATI VE APPLI CATI ONS

Derivative Applications 2012

Derivative Applications 2012

THE EXPECTED RETURN

Derivative Applications 2012

with 100% Participation

. At maturity, the investor receives a minimal reimbursement of 100% of

Index Sponsor Deutsche Brse AG

with 100% Participation

Where i is the constituent of the Underlying.

with 100% Participation

with 100% Participation

(the Underlying). The Security offers a full

up to the barrier level of 150%. If the

Index Sponsor STOXX Limited

The Dow Jones EURO STOXX 50 Price Index

is the intellectual property (including registered trademarks) of STOXX Limited, Zurich,

* wi|| Le celerminec cn lhe lnilic| Fixing Dcle

The Dow Jones STOXX 50 Price Euro

FUND LINKED PRODUCTS

FUND LINKED PRODUCTS

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