Arnold Kan, JP Morgan Chase Bank, Taiwan

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C:\DOCUME~1\f015060\LOCALS~1\Temp\c.data.f015060.notes_cdi\Elise SPI

PRESENTATION EDIT.ppt

This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including such client’s subsidiaries, the “Company”) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan.

The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or accounting effects of consummating a transaction. The information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects.

JPMorgan's policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investors.

JPMorgan is a marketing name for investment banking businesses of J.P. Morgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities for Asian clients are performed by certain of such subsidiaries in Asia and/or J.P. Morgan Securities Inc. and/or its banking affiliates.

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Disclaimer: Asia Pacific in English

法規節錄

主要效益

I

保險業從事衍生性金融商品交易應注意事項 :

五… .. 得基於避險目的，從事下列與前述資金運用相關之衍生性金融商品交易 :

（一）認購（售）權證。（二）選擇權或期貨。（三）證券商經核准於營業處所經營之衍生性金融商品。（四）銀行經許可或核准辦理之衍生性金融商品。（五）最近一年長期債務信用評等等級經中華信用評等公司或其他經主管機關認可之國內外信用評等機構評定達 twA －級或相當等級以上之國內外金融機構承作之各種標的之衍生性金融商品。

1. 放寬以避險為目的所投資的衍生性金融商品類型 , 並納入與避險項目具有高度相關性的避險衍生性金融商品

2. 增加保險業的避險效率 , 更大幅減少保險業避險成本

II

七、保險業為增加投資效益，得從事下列衍生性金融商品交易：認購（售）權證 , 經主管機關依期貨交易法第五條公告期貨商得受託從事之期貨交易

八、因增加投資效益所持有之國內或國外衍生性金融商品，其契約總（名目）價值，合計不得超過各該保險業業主權益之百分之四十，其中國外部分不得超過各該保險業業主權益之百分之二十

1. 放寬非避險目的的投資 , 也就是俗稱的套利 , 投資 , 保險公司不必具有現貨 , 就可以投資 , 不只讓投資彈性增加 , 也增加了投資收益

2. 由於衍生性商品金融商品財務槓桿較高 , 金管會規定 , 以非避險為目的的投資 , 不得超過淨值40%

III

十、保險業投資之結構型商品應符合下列條件，其投資總額不得超過保險業資金之百分之十

1. 提高投資結構型商品的限額 , 投資額度部分由現行各該保險業 5% 提高至 10%, 對最終日未逾五年的結構商品 , 其到期本金之保本比率得為 90%以上

2. 預計將有 1,386 億元注入國內衍生性金融商品市場

New Derivatives Guideline for Insurance Co in Taiwan

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Agenda

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Low Equity Barrier Enhanced Notes (LEADs)

Equity Based Collateralized Obligations (ECOs)

Equity Default Swaps

Credit Long Short SPI

Proxy Basket SPI

Synthetic Portfolio Insurance (SPI)

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Risky Asset

Constant Proportion Portfolio Insurance (CPPI)

Investment is comprised of two parts—Risky asset + Risk Free Asset (Zero coupon bonds)

The higher the amount of risky assets in the portfolio, higher the potential returns over the principal amount.

This fraction of the risky asset in the Dynamic Basket is referred to as “Exposure”

The exposure is adjusted from time to time to maximize potential return and ensure principal protection

CPPI rebalances between an investment in the Risky Asset and a zero coupon

bond to provide principal protection

Variableinvestme

nt

Investment inRisky Asset

Investment inZero Bond

Zero coupon bond

Dynamic Basket

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Constant Proportion Portfolio Insurance—an example

In order to guarantee a certain principal on maturity, we can invest an amount equal to the principal discounted by the risk free rate

For Example, to ensure a return of $100 after 10 years, it is sufficient to invest in a risk free zero coupon bond trading at $60 if risk-free rate is 5.3%

The remaining $40 can be invested in risky assets to generate additional returns (Cushion)

This creates a portfolio of risk-less assets (Zero Coupon Bonds) and Risky assets and is referred to as the “Dynamic Basket”

Principal assurance through risk-less assetsPrincipal assurance through risk-less assets

100

60

Time to maturity

Valu

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f ass

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Cushion

Risk-less bonds

Assured principal value

Bond Floor

Year 1 Year 2 Year 3 Year 4 Year 10

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Using crash size to define threshold for downside protection

Principal protection under crashPrincipal protection under crash

Valu

e o

f D

yn

am

ic B

ask

et

Proxy Basket Risk-less Asset

(170)%

100%

Initial allocation After crash

60%

At maturity

Risk-Free ra

te15% Crash of proxy basket

Reallocation

ReallocatedDynamic Basket

Principalprotection

Initialinvestment

(1) (2)

(3)

0%

The amount by which the risky asset can depreciate in one single day is also estimated and is referred to as the “Crash Size”

Suppose we assume a Crash Size of 15% We will use Crash Size to increase the exposure to

the proxy basket beyond the the initial cushion

Initial Portfolio (1) With this estimate, we can invest (100—60)/(0.15)

$270 in risky assets

After Crash (2) If a 15% crash occurs, then value of the risky asset

reduced to $230 The risky asset is sold off at this reduced market

value and reinvested in riskless asset

Reallocated Dynamic Basket (3) Investment in the riskless asset = 230—170 = $60 This amount ensures principal guarantee at

maturity

Negative Values indicate Leverage

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Introduction to Synthetic Portfolio Insurance (SPI)

What if SPI?

Developed by JPMorgan as an OTC replication of the traditional Constant Proportion Portfolio Insurance (CPPI) strategy

In a standard CPPI structure, the investor buys units of a fund that is created and managed by the Asset Manager for the purpose of the CPPI structure

This arrangement gives rise to the following limitations Equity exposure can fall to zero Currency protection is not necessarily possible The underlying funds value is not verifiable

In the JPMorgan SPI structure there is no fund vehicle involved and the investor buys a zero coupon bond plus a call option on the NAV of the notional portfolio which synthetically replicates an enhanced CPPI strategy

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SPI structural diagram

Structural diagram: Investor invests 100% in SPI structure Structural diagram: Investor invests 100% in SPI structure

IssuerInvestor JPM

100%

Instrument

Funding

Funding 100%

SPI basket

AllocationFund

ZC

IssuerInvestor JPM

Instrument

Max (SPI Dynamic Basket - 100%, 0)

100%

SPI basket

SPI Dynamic Basket

Max (SPI Dynamic Basket, 100%)

Payoff at maturity: Investor receives higher of 100% Principal invested and SPI Dynamic Basket ReturnPayoff at maturity: Investor receives higher of 100% Principal invested and SPI Dynamic Basket Return

SPI structure

SPI structure

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Benefits of SPI

Capital Protection Participation in underlying while maintaining capital protection.

Flexible Underlying Risk-return optimised portfolio can be diversified across fund managers, investment strategies or asset classes

Minimum Equity Exposure Prevents the synthetic portfolio from becoming ‘cash-locked’ by setting a minimum proportion of assets that will be held in equity; This allows the portfolio to participate in a market rebound, without affecting the capital guarantee.

No External Investment vehicle

No requirement to set up purpose built investment vehicle, hence very fast delivery of the product in the market

Full Currency Protection Standard CPPI structures can be offered with currency hedging overlays, but these do not offer the same transparency and efficiency as the full quanto protection that the JPMorgan SPI structure offers.

Verifiable & Transparent Pay-off Re-balancing of the portfolio can be tracked using market data, on a daily

basis. JPMorgan will actively reallocate the notional portfolio according to a ‘Dynamic Allocation Strategy’ in line with the predefined principles. Thus SPI is not a ‘black-box’ fund unit product

ISDA Documentation The product is delivered in an efficient OTC format. Exposure may be delivered in Swap or option format or in combination with guaranteed cash-flows traded and confirmed as a regular OTC derivative using standard ISDA format

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Agenda

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Proxy Basket SPI


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What is a Proxy Basket strategy?

The Risky Asset in the Dynamic Basket is a basket of currencies referred to as the “Proxy Basket”

The strategy synthetically replicates an asset which is constructed using currency pairs denominated vs. JPY

The weights assigned to currency pairs in the asset are optimized based on historical data in a way that the movements of the currency pairs offset each other

Assuming optimal offset the basket maintains the same value while earning a high carry based on the interest rate differential of the underlying currency pairs

JPMorgan believes that there is a low probability of a significant mismatch in the offset of the currency pairs

Basket ofcurrencies

JPY

Offset

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JPMorgan believes a basket of foreign currency can be constructed to track the movement of JPY closely

JPMorgan has performed rigorous analysis to construct the appropriate combination of different currencies to give optimal yield and correlation to JPY appreciation/depreciation

The weightings are shown in the table on the right as an example of the Synthetic Asset Construction

The basket is optimized to grow at 5%¹ carry

OverviewOverview

Proxy Basket construction

¹ Basket-Carry is 5.5%. An embedded fee of 50bp is charged to cover replication costs

Currency Weighting

Australian Dollar (AUD) (5.314)% (SHORT)

South Korean Won (KRW) 31.034% (LONG)

European Union Euro (EUR) (1.703)% (SHORT)

Singapore Dollar (SGD) (16.255)% (SHORT)

British Pound (GBP) 20.558% (LONG)

Thai Baht (THB) 19.911% (LONG)

Swiss Franc (CHF) (23.455)% (SHORT)

Indian Rupee (INR) 88.608% (LONG)

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High correlation between JPY and basket High correlation between JPY and basket

Source: JPMorgan, as of 4/6/06

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105

110

115

120

125

130

135

140

145

100 105 110 115 120 125 130 135 140

J PY depreciation

Bask

et d

epre

ciat

ion

Proxy Basket correlated to JPY

Correlation JPY and Basket

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100

105

110

115

120

125

130

135

140

145

01/ 01/ 99 03/ 02/ 00 05/ 02/ 01 07/ 02/ 02 09/ 01/ 03 10/ 31/ 04 12/ 31/ 05

J PY spot Basket Eqv. spot

Source: JPMorgan, as of 4/6/06

Historical spot price of JPY and Basket equivalent spot

Spot price of JPY and Basket Equivalent spot show very similar movementsSpot price of JPY and Basket Equivalent spot show very similar movements

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Growth of Proxy Basket via SPI strategy

The Proxy Basket grows at the rate of the carry of 5% (assuming there are no tracking errors)

Out of this growth 2% fee are paid to the client

The whole structure initially leverages through the CPPI payoff by 270%

Guaranteed payment of 1% per annum on the notional payable quarterly

MechanicsMechanics

Carry5.0%

Gro

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of

Pro

xy B

ask

et

Fee paid2.0%

Growth3.0%

270% Initial leverage

270% Initial leverage

Growth8.1%

(Realized at

maturity)

Annualpayout5.4%Guarante

ed 1.0% payable

quarterly

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Credit Long-Short – Structure Overview

Credit Long-Short StrategyCredit Long-Short Strategy

Single Name Credits

Portfoli

o

Mezzanine

“Super Senior”

Equity

Credit 1

Credit 2

Credit 3

Credit 4

Credit...

Actively managed mezzanine

CSO tranche

Short portfolio

CDSA CD

SB CD

SC CD

SX

Long tranche Long portfolio

The strategy attempt to achieve a “delta neutral” state and maintain a “convex” return profile, thus making returns relatively neutral to movements in credit

spread

The credit long-short strategy will take exposure to (i) a long Junior Mezzanine CSO Tranche and (ii) a selected short portfolio of single name corporate credit derivatives

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Agenda

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Proxy Basket SPI


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To achieve a convex return profile neutralising movements in credit spreads

Credit Long-Short - Rationale

Continued lack of apparent trend in credit spreads1

Continued lack of apparent trend in credit spreads1

iTraxx 3-6 mid spread levels

200

300

400

500

600

700

800

Oct-03 Apr-04 Oct-04 Apr-05 Oct-05

Average

Idiosyncratic risk still highIdiosyncratic risk still high

Correlation levels for tranched Junior Mezzanine at historical lows

Correlation levels for tranched Junior Mezzanine at historical lows

Leveraged and M&A bids

Oil price and commodity price effects

Auto sector uncertainty

0%

5%

10%

15%

20%

25%

30%

35%

Sep-04 Mar-05 Sep-05 Apr-06

3-7 CDX Tranche3-6 iTraxx Tranche

Macro

con

sid

era

tion

s

Not take exposure to “first loss” Equity Tranches

Give short credit exposure to “bearish” names

Take Junior Mezzanine Tranche exposure to benefit from any correlation increases

Str

ate

gy

1 Source: JPMorgan, Morgan Markets, M&G as of April 2006

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Spread risk profile – An illustration

(20%)

(10%)

(0%)

10%

20%

30%

40%

50%

50% 80% 102% 130% 160% 190%

Spread as % of current spreads

Chan

ge in

MTM

(100%)

(50%)

0%

50%

100%

150%

50% 75% 100% 125% 150% 175% 200%

Spreads as % of current spreads

Chan

ge in

MTM

Illustrative sensitivity to instantaneous spread change1

Illustrative sensitivity to instantaneous spread change1

Illustrative Long Mezzanine tranche—Change in MTM1

Illustrative Long Mezzanine tranche—Change in MTM1

Illustrative short CDS Portfolio—Change in MTM1

Illustrative short CDS Portfolio—Change in MTM1

(100%)

(50%)

0%

50%

100%

150%

50% 75% 100% 125% 150% 175% 200%


Chan

ge in

MTM

Leverage2

¹ Spreads move on the 1st day ² Illustrative leverage used in order for the portfolio to remain in a delta neutral state; Tranche leverage of 2.5 times used; CDS portfolio leverage of 9 times

the tranche notional used; The chart above shows hypothetical change in MTM (mark-to-market) of a chosen CSO tranche and Single name CDS portfolio and their combination in ”M&G Credit Fund”

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Credit Long-Short – A case study

¹Principal protection provided by AAA rated collateral

Short portfolio

Prudential M&G Credit SPI overviewPrudential M&G Credit SPI overview

Actively managed junior mezzanine CSO

tranche

Credit Fund

Principal protection¹

M&G Credit Fund SPI Notes¹

SPI(Synthetic Portfolio

Insurance)

CDSA

CDSB

CDSC

CDSX

Long tranche

M&G is the trading name of M&G Investment Management Limited , a wholly owned subsidiary of Prudential plc. M&G has over €2371 billion assets under management and employs over 1481 investment professionals

M&G Credit Fund SPI Notes will provide investors with principal protected exposure to the M&G Credit Fund (“The Fund”)

The Fund will take exposure to (i) a long Junior Mezzanine CSO tranche referencing a portfolio of primarily investment grade corporates and (ii) a selected short portfolio of single name corporate credit derivatives

M&G will attempt to maintain a convex return profile for The Fund, thus making returns relatively neutral to movements in credit spread whilst focusing on idiosyncratic default risk

The Notes returns will be determined by The Fund’s performance in addition to leverage which will be provided through the application of Synthetic Portfolio Insurance (“SPI”) technology

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Illustrative Fund return profile

The net asset value (“NAV”) of The Fund will reflect the mark-to-market of the combination of the long junior mezzanine and short CDS portfolio

Returns on The Fund will represent a combination of carry and mark-to-market changes

M&G will manage The Fund within preset limits6

Note: The above analysis shows hypothetical returns based on certain assumptions. 1 Includes a Delta adjusted execution cost of 2% of the WAS and a 1% administrative cost charged by the swap counterparty2 These return results are based on a hypothetical leverage of 2.5 times within The Fund3 Implied spreads (as of valuation date March 31, 2006) for a delta hedged 3.5%-5.5% 10Y tranche were used; CDS Portfolio leverage of (22.5) required to

maintain delta neutral state4 Delta slide represents the change in Mark to Market value as a result of the decrease in the time to maturity; Premium represents the Spread

received/paid for selling/buying protection5 Assumed to be the 10 year EUR swap rate as of April 20066 JPMorgan monitors the level of leverage allowed within The Fund by running several scenarios on a daily basis. The process allows the Fund to maximise

the exposure to equivalent of a 30% crash size. More detail on the scenarios applied can be given upon request

Long Junior Mezzanine Tranche3

Delta slide (10Y to 9Y)4 = 4.7% Premium4 = 11.0%

Hypothetical carry = 15.7% CDS Portfolio3

Delta slide (10Y to 9Y) 4 = 0.20% Premium4 = 0.80%

Hypothetical carry = 1.00%

Fund return assumptions (preliminary strategy)

Fund return assumptions (preliminary strategy)

Underlying portfolios Long Junior Mezzanine: 10Y WAS = 93bp

CDS portfolio: 10Y WAS = 87bp Tranches

Long mezzanine attachment = 3.5—5.5%

Illustrative calculation of CarryIllustrative calculation of Carry

Hypothetical Fund Return computation2 (1Y)Hypothetical Fund Return computation2 (1Y)

Tranche returns (1Y)

A. Long Junior Mezzanine3

B. CDS Portfolio return3

C. Operational Costs1

Gross Fund return1 (A + B+C) 13.0%

Annual Portfolio Management Fee (1.5)%

Collateral Spread/yield5 4.1 %

Net Fund return 15.6%

1 year return

Carry

x

x

2.5

(22.5) 1.0%

15.7%

Leverage =

=

=

x

39.0 %

(22.5)%

(3.5)%

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Illustrative Fund sensitivity—Single name spread widening

Illustrative tranche leverage of 2.5 times used;1 This is achieved using an average name in the portfolio2 Graphically represents the MTM effect of a spread increase of 200bp for an average name in the portfolio of the long Junior Mezzanine tranche at the end of the 1st year of trading; The return for the 1st year does not include Management costs 0f 1.5% and Collateral returnsNote: The charts above shows hypothetical changes in MTM (mark-to-market) of the NAV of The Fund. Performances can vary significantly depending on the assumptions taken.

(6%)

2%

9%

17%

24%

32%

39%

47%

54%

50% 75% 100% 125% 150% 175% 200%

No tweak Day one tweak sensitivity

Hypothetical Fund Return—200bp single name spread tweak on Day 11

Hypothetical Fund Return—200bp single name spread tweak on Day 11

(0.02%)

(1.0%)

CF MTM change (%)


Hypothetical Fund Return—200bp single name spread after one year12

Hypothetical Fund Return—200bp single name spread after one year12

(6%)

2%

9%

17%

24%

32%

39%

47%

54%

50% 75% 100% 125% 150% 175% 200%

No tweak Day one tweak sensitivity

13.0%

11.0%


CF MTM change (%)

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(10%)

(5%)

0%

5%

10%

15%

20%

25%

30%

35%

50.00% 70.00% 90.00% 110.00% 130.00% 150.00%

-15% Correlation tweak 0% Correlation tweak

15% Correlation tweak

Illustrative Fund sensitivity—Correlation spikeHypothetical CF MTM change v Correlation and spread tweak1

Hypothetical CF MTM change v Correlation and spread tweak1


Hypothetical scenarios have been devised to replicate a potential distortion in the correlation market

Scenario mechanics

Defining the “15% Correlation tweak” example The correlation level for the lower attachment

point is shifted to 85% of the current value The correlation level for the Upper

attachment point is shifted to 115% of the current value

Defining the “-15% Correlation tweak” example The correlation level for the lower attachment

point is shifted to 115% of the current value The correlation level for the Upper

attachment point is shifted to 85% of the current value

Spread levels for the entire portfolio are proportionately shifted to generate the convex return structure

¹ The MTM effects are consistent with a Gross Fund return where the Tranche leverage is 2.5Note: The charts above shows hypothetical changes in MTM (mark-to-market) of the NAV of The Fund. Performances can vary significantly depending on the assumptions taken.

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Illustrative 10yr SPI Coupon format sensitivity

(10%)

0%

10%

20%

30%

40%

50%

(7.4%) (2.4%) 2.6% 7.6% 12.6% 17.6% 22.6% 27.6%

Net Fund Return

Net EUR SPI Note IRR Net Fund Return

EUR Note IRRs for given fund returnEUR Note IRRs for given fund return

Hypothetical IRRs—EUR Notes Hypothetical IRRs—EUR Notes

Hypothetical Gross Fund

Return¹ Hypothetical Net

Fund Return¹ Gross EUR Note IRR²

Net EUR Note IRR²

(10.0%) (7.4%) 0.1% 0.1%

(5.0%) (2.4%) 0.5% 0.3%

5.0% 7.6% 7.9% 6.7%

10.0% 12.6% 16.6% 14.3%

13.0% 15.6% 23.2% 20.7%

15.0% 17.6% 27.8% 25.3%

20.0% 22.6% 38.5% 35.5%

25.0% 27.6% 50.3% 47.6%

(10%)

0%10%

20%30%

40%

50%

(7.4%) (2.4%) 2.6% 7.6% 12.6% 17.6% 22.6% 27.6%

Net Fund Return

Net USD SPI Note IRR Net Fund Return

USD Note IRRs for given fund returnUSD Note IRRs for given fund return

Hypothetical IRRs—USD Notes Hypothetical IRRs—USD Notes

Hypothetical Gross Fund

Return¹ Hypothetical Net

Fund Return¹ Gross USD Note IRR²

Net USD Note IRR²

(10.0%) (7.4%) 0.1% 0.1%

(5.0%) (2.4%) 0.7% 0.5%

5.0% 7.6% 10.1% 8.7%

10.0% 12.6% 20.1% 17.6%

13.0% 15.6% 27.2% 24.4%

15.0% 17.6% 31.7% 28.7%

20.0% 22.6% 42.7% 39.9%

25.0% 27.6% 55.3% 51.9%

1 Hypothetical Fund returns on an annual basis, assumed to be constant through the life of the trade. 2 Hypothetical IRR for SPI Notes. Gross IRR before considering 1% Principal protection fee; Net IRR after considering 1% Principal protection fee. Quanto

adjustment are included in the calculation of both Gross and Net Note IRRs. Performances can vary significantly depending on the assumptions taken.

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Equity Default SwapsEquity Default SwapsCredit Default SwapsCredit Default Swaps

Equity Default Swaps: How does it work?

RiskReference entity

Protection buyer

Fee/premiumProtection seller Contingent

payment on Default (losses)

A credit default swap is essentially a guarantee whereby the protection buyer transfers the risk that the reference entity will be subject to a credit default event

In return for the protection, the buyer pays a protection fee to the seller (in a similar manner to an insurance premium or guarantee fee)

On a credit default event, the buyer delivers a portfolio of obligations of the reference entity, and receives par (or settles a net cash amount)

A credit default event is defined as one of the following: bankruptcy, failure to pay, restructuring

It is market practice to agree on a physical delivery of a reference security

RiskReference stock

Protection buyer

Fee/premiumProtection seller Contingent

payment on Equity Default Event

An equity default swap is a contract whereby the protection buyer transfers the risk that a reference stock will be subject to an equity default event

In return for protection, the protection buyer pays a per annum fee to the protection seller

On an equity default event, the protection seller pays a recovery value to the protection buyer. the swap is settled and there are no further cashflows

An equity default event occurs if the closing price of the reference stock is at or below 30% of its value at inception

It is market practice to fix the recovery value at 50% of the notional amount

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Equity Default Swaps: How does it work?

Credit default event and equity default eventCredit default event and equity default event

0

50

100

150

200

250

300

350

400

J an-99 Aug-99 Mar-00 Oct-00 May-01 Dec-01

Barrier(354 x 0.30) = 106.2

Swissair [Bloomberg: SRN VX]

Equity default event at 104.5 (23 April 2001)

Inception at 354 (3 May 1999)

Bankruptcy

filed 2 October 2001

The equity default event is very transparent, as it is based on the closing share price of the reference name and whether it is at or below 30% of the share price at EDS inception

Similar to ‘traditional’ credit derivatives, where the occurrence of a credit default event will trigger a payment from the protection seller to the protection buyer

For traditional credit derivatives, the credit default event is normally defined as the occurrence of either: Bankruptcy Failure to pay Restructuring

Due to the complexity of definition, it is sometimes difficult to determine whether a credit default event has occurred or not

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EDS Cashflows—No Equity Default EventEDS Cashflows—No Equity Default Event EDS Cashflows—Equity Default EventEDS Cashflows—Equity Default Event

Equity Default Swaps: How does It Work?

Protection Seller receives

Protection Seller pays

3 m6 m9 m1 Y 2 Y 3 Y 4 Y 5 Y

EDS SpreadAccrued up to the

Equity Default Date

Equity Default Event

1-Recovery Value=50%

Protection seller receives

Protection seller pays

3 m6 m9 m1 Y 2 Y 3 Y 4 Y 5 Y

EDS Spread:

Paid quarterly in arrears

EDS of 500bp p.a. 125bp per quarter

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Investor Sells equity protection on an ECO tranche referencing a number of equities JPM risk-manages through entering into a number of Equity Default Swaps in the

market to offset Losses are allocated bottom-up as per tranche seniority i.e. First Loss to Mezzanine to

Senior tranche The events observed are Equity Default Events

The mechanics of ECOThe mechanics of ECO

Equity based collateralised obligations—ECOs

Super-senior

Mezzanine

First loss risk

JPMorgan

SPV

Tranched riskEquity Default Risk

Stock 1

Stock 2

Stock 3

Stock ...

Stock n-2

Stock n-1

Stock n

ECOs

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ECO—impacts of defaults on coupon and capital redemption

Assumptions:

Maturity: 5 years

Portfolio: Globally Diversified Basket

Quarterly Coupons

EDS portfolio of e.g. 100 names

Recovery rate assumed to be 50%

This example is for illustrative purposes only and does not reflect real pricing

Mechanisms of ECO’sMechanisms of ECO’s

Senior Tranche

Mezzanine ECO

First Loss Tranche0%

5%

10%

100%

1 2 3 94 5 6 7 8

Capital Redemption at Maturity

100%80%

20%

60%40%

10 or moreNumber of Defaults

Coupon paid quarterly as a % of the headline coupon

10080%

20%

60%40% Number of

Defaults

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Comparison of ECOs v. CDOsComparison of ECOs v. CDOs

Comparison of CDOs and ECOs

Equity based Collateralised Obligations Synthetic CDOs

Reference Names Names publicly traded on a stock exchange Majority of the large and liquid single stocks

Names traded in the CDS market Majority of the names with outstanding debt

Default Trigger Equity Default Event Single Stock is trading below a percentage of the share

price at inception

Credit Default Event Bankruptcy Failure to pay Restructuring

Loss on eachreference name

Weighting of the reference name within the portfolio Weighting of the reference name in the portfoliomultiplied with the loss in the reference obligation

Impact of supplyand demand in theequity market

Yes No

Impact of supplyand demand in thecredit market

No Yes

Transparency ofDefault Event

High Degree of Transparency, as the Equity DefaultEvent is observed on the official closing share price

Might leave some room for discussions /interpretations

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The concept of First-to-default

The First to default out of the basket causes the swap to terminate, and the protection seller pays: (1-Recovery Rate) * Notional Amount

First-to-default swap N to default swap

The N default out of the basket causes the swap to terminate, and the protection seller pays: (1-Recovery Rate) * Notional Amount

1) Stock C defaults: swap terminates2) Stock D defaults: no impact3) Stock E defaults: no impact



3m6m9m 1Y 2 Y 3 Y 4 Y 5 YEDS Spread Accrued up to the Equity Default

Date


A

CB

D

F

First to default basket:

E

1) Stock C defaults: no impact2) Stock D defaults: no impact3) Stock E defaults: swap terminates



3m6m9m 1Y 2 Y 3 Y 4 Y 5 YEDS Spread Accrued up to the Equity Default

Date


A

CB

D

F

N to default basket (N = 2)

E

NB: this structure is often referred to as a “First-to-Default Swap” even though it is technically an “N to default swap”

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LEADs Indicative Terms

Low Equity Barrier Enhanced Notes - LEADs

First-to-default Equity swaps can be structured in a capital protected format

A LEADs (Low Equity Barrier Enhanced Notes) is a capital protected note, where the coupon depends on the number of Equity Default Events during the life of the note

At each coupon payment date, the number of Equity Default Events that have occurred so far is calculated

After an initial threshold, the coupon will be reduced for every additional Equity Default Event in accordance to a specified schedule

An Equity Default Event is triggered, if at any date, one of the underlying shares is trading below 30% of it’s level at inception

Maturity: 5 years

Coupon: X% subject to EDE paid semi-annually

Principal protection: 100%

Note

bu

yer

rece

ives

Note

bu

yer

pays 6m 1Y 2 Y 3 Y 4 Y 5 Y

100% Notional paid on Start

Date

100% Notional re-paid at

Maturity + Final Coupon

Equity Event 1

Equity Event 2

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Documents

Arnold Kan, JP Morgan Chase Bank, Taiwan