Structured Product Teach-In

11th November 2010

• Who we are• What is a structured product?• Under the bonnet• Actual pricing• We don’t just do equity linked notes• Secondary market• Summary

Agenda

Who we are

• LLP – Team of 6 + Non-Executive Chairman• FSA authorised securities and futures firm• Origination and distribution business that offers and supports Private

Placement securitised derivative products to professional asset managers and institutions in the UK

• Issued over GBP558mm primary market and over GBP250mm secondary market trading in two full financial years since 1 August 2008

Introduction

How we operate

• We talk to you directly• We coordinate each bank’s trading, structuring and settlement teams, issuing

securities that optimise your investment views• You trade and settle with the respective banks directly using Crest/Euroclear• We coordinate, advise and support all sales and redemptions for each bank • We advise on product platforms and regulatory issues, deferring to external

lawyers where necessary• We offer structured products and derivative strategy training • We can offer you access to the products, platforms and trading expertise of

five leading investment banks• In addition, we are able to source swaps (bonds and derivatives) from

additional third parties where attractive• Our website is fully functioning and will act as a portal for clients to access the

primary and secondary market products of each of our partner banks

Costs

• We are not an extra layer of costs but are replacing each bank’s resource in this market in return for a share of its P&L

• We are not brokers who will change [XX%] on top of the banks’ issue costs• We have agreed with each bank that charges will be in a range of 0.5%-2% of

notional, to include prospectus, hedging, taxation advice and P&L.• Our fee is a share of the P&L part of the costs – we can resource ourselves much

more efficiently than can a sales team within a bank. • Every penny is real to us - this will be reflected in competitive pricing• We aim to be extremely agile and dynamic

Banks we work with predominantly

• HSBC

• Rating AA / Aa2• Solid Capital Base, popular counterparty.• One of the tightest Credit Default Swaps• Key vehicles; Exchangeable Warrant Programme; MTN Note Programme

• JPMorgan

• Rating A+ / Aa1• Solid capital base, one of tightest Credit Default Swaps• Key vehicles; EIS, MTN

• Societe Generale

• Rating A+ / Aa2• Solid capital base. Strong links to its Government• Leading derivatives player• Key vehicle; Lyxor Funds (Lux), ESOL Notes, CODEIS (Lux)

Banks we work with

• Citi

• Rating A / A3• Relatively good funding spreads• Best secondary market process• Key vehicles; Symphony Structured Products (Jersey) Ltd; Allegro Investment Corporation

• Nomura

• Rating A- / Baa1• Good funding spreads.• Key vehicle; STAGs (Securities Taxed As Gains) exchangeable bonds (similar to Barclays Simple)• EIS, MTN

• Collateralization

• Most structures can be collateralized to mitigate counterparty credit risk if required

What is a Structured Product ?

STRUCTURED PRODUCT

STRUCTURED PRODUCT

Income or Growth

Income or Growth

TaxationTaxation

Investment Term

Investment Term

CounterpartyCounterparty

Underlying Asset

Underlying Asset

Investment Objective

Investment Objective

WrapperWrapper

Capital Protection

Capital Protection

Something where the investor sets the parameters

MULTI ASSET UNDERLYINGSMULTI ASSET

UNDERLYINGS

RISK MANAGEMENT

RISK MANAGEMENT

Predictable paths

Predictable paths

Conditional/ Unconditional

return

Conditional/ Unconditional

return

Defined Risk & Return

Defined Risk & Return

Reduced VolatilityReduced Volatility

Capital Protection

Capital Protection

Funds/ Absolute

return

Funds/ Absolute

return

Volatility/ Correlation/

Dividends

Volatility/ Correlation/

Dividends

Inflation/ Commodities

Inflation/ Commodities

Interest rates

Interest rates

Currencies/ Credit

Currencies/ Credit

Equities/ Indices

Equities/ Indices

Liability Driven

Liability Driven

WRAPPERSWRAPPERS Medium Term Notes

Medium Term Notes

Warrants/PCC/ Excluded Indexed

Securities

Warrants/PCC/ Excluded Indexed

SecuritiesUCITS IIIUCITS III

Under The Bonnet

It’s all about the maths

Using examples, this presentation aims to illustrate how seeminglycomplicated structured products can be decomposed into simplercomponent parts.

Having determined the component parts of these sample products,the pricing parameters that determine the value of these component parts can then be explained

Funding Swap + Option

GBP1.00Investor’s

Cash

Share Price at Issue 100.00p

Funding Swap 75.00p

Aggregate Costs 1.50p

Option Premium 23.50p

OptionProvidingEconomic

Return

GBP0.75Investor’s

Cash

OptionProvidingEconomic

Return

What determines Structured Product pricing?

• Two Price Components

• Zero Coupon Bond Price• Interest rates• Credit

• Option Price• Volatility• Time to expiry• Spot price• Strike price• Dividends• Interest rates

Volatility – It’s all about the bell curve!

Or in simple terms!

High ImpliedVolatility

Low ImpliedVolatility

Actual Pricing

Type FTSE S&P Eurostoxx Nikkei

100% PP 75% 58% 68% 44%

95% PP 100% 81% 92% 62%

50% soft 170% 120% 158% 64%

Note:

All GBP (hedged) with a 5yr term and assuming HSBC / SG

PP – principal protection, 50% soft refers to a European KIP

Participation Summary

Participation demand

High interest rates

Low option prices

Strong market trend

Income demand

Low interest rates

High option prices

Weak market trend

Participation Notes

Twin-Win

Autocallables / BRC’s

We boil everything down to this

FTSE S&P Eurostoxx Nikkei

9.5% 8.4% 9.5% 5%

GBP (hedged) 6 years, auto-call at 100%, 50% European KIP

Standard Auto-Call Pricing

Increase or decrease the risk / return profile?

Decreasing Risk / Return

• Defensive Autocallables single most popular structure over last 3 years• Pick a return target and downside and work back with the auto-call barriers• With lower rates the potential coupons (nominal returns) are lower (see handout)• Some clients will to take a view on more than one market to boost returns

We don’t just do equity linked notes!

What we have on the go

• Bonds – clients have discussed hedging rising yields, playing the shape of the yield curve as well as simple cash enhancement (fixed-floating)

• Currencies – EM vs USD currency baskets potentially trading next week• Commodities – not as popular as 2006/07 as rates low and many commodities in contango

though there are some interesting ideas on gold

Secondary Market

• Derivative contracts are as liquid as their underlyings, which are in the main major market indices or stocks

• The value of the ‘package’ should reflect the fair value of the sum of the component parts, however, this may mean the investor gets back less than the amount invested

• Bid/offer should be 50bps either side of the fair price on mainstream assets• All Structures are priced on a daily basis and these can be tracked on Bloomberg/ Reuters or

via the www.catleylakeman.com• It is quite normal for structures to be traded prior to maturity or bought post launch• Catley Lakeman can provide guidance as to how each trade will M2M during its life, given

chosen inputs

Private Placement Structured Products are:

• No more complicated than equities and bonds• Unique in their ability to precisely tailor your risk/return objectives• Liquid and cost efficient• Certain to deliver the results set out to your clients from outset

• Disclaimer

• The information in this document is derived from sources believed to be reliable but which have not been independently verified. Catley Lakeman

• Securities makes no guarantee of its accuracy and completeness and is not responsible for errors of transmission of factual or analytical data, nor is it

• liable for damages arising out of any person’s reliance upon this information. All charts and graphs are from publicly available sources or proprietary data.

• The opinions in this document constitute the present judgment of Catley Lakeman Securities, which is subject to change without notice.

• This document is neither an offer to sell, purchase or subscribe for any investment nor a solicitation of such an offer. This document is intended for the

• use of institutional and professional customers and is not intended for the use of private customers. This document is not intended for distribution in the

• United States of America or to US persons. This document is intended to be distributed in its entirety. No consideration has been given to the particular

• investment objectives, financial situation or particular needs of any recipient.

• Catley Lakeman Securities is a LLP registered in England and Wales, Registered Office : One Eleven Edmund Street, Birmingham, B3 2HJ. Registration

• Number: OC336585, Vat Number: 936371705, FSA Reference: 484826