TERMINOLOGIES USED IN DERIVATIVES (FUTURES, OPTIONS AND SWAPS)

1. American Depository Receipts (ADRs - An American Depositary Receipt (ADR) is a certificate that
represents shares of a foreign stock owned and issued by a U.S. bank. The foreign shares are usually
held in custody overseas, but the certificates trade in the U.S. Through this system, a large number
of foreign-based companies are actively traded on one of the three major U.S. equity markets (the
NYSE, AMEX or Nasdaq)

Most ADRs are denominated in U.S. dollars and are traded on a U.S. stock exchange.

(EXAMPLE) - To create an ADR, a U.S.-based broker/dealer purchases shares of the issuer in

question in the issuer's home market. The U.S. broker/dealer then deposits those shares in a bank in
that market. The bank then issues ADRs representing those shares to the broker/dealer's custodian
or the broker-dealer itself, which can then apply them to the client's account.

Let's assume the ADRs of XYZ Company, a French company, pay an annual cash dividend of 3 euros
per share. Let's also assume that the exchange rate between the two currencies is even -- meaning
one Euro has an equivalent value to one dollar. XYZ Company's dividend payment would therefore
equal $3 from the perspective of a U.S. investor. However, if the euro were to suddenly decline in
value to an exchange rate of one euro per $0.75, then the dividend payment for ADR investors
would effectively fall to $2.25. The reverse is also true. If the euro were to strengthen to $1.50, then
XYZ Company's annual dividend payment would be worth $4.50.

2.Credit Default Swap. A credit default swap is a contract whereby the parties agree to isolate and
separately trade the credit risk of a third party. In a credit swap agreement, the buyer agrees to
make one or more payments in exchange for the agreement of the seller to pay an amount equal to
the decrease in value of a specified bond or a basket of debt securities upon the occurrence of a
default or other credit event relating to the issuer of the debt. In such transactions, the buyer
effectively acquires protection from decreases in the value of thesecurities relating to the
creditworthiness of the debt issuer. The seller agrees to provide creditprotection in exchange for the
premium payments.

(EXAMPLE) - suppose Bob holds a 10-year bond issued by company XYZ with a par value of $1,000
and a coupon interest amount of $100 each year. Fearful that XYZ will default on its bond
obligations, Bob enters into a CDS with Steve and agrees to pay him income payments of $20 (similar
to an insurance premium) each year commensurate with the annual interest payments on the bond.
In return, Steve agrees to pay Bob the $1,000 par value of the bond in addition to any remaining
interest on the bond ($100 multiplied by the number of years remaining). If XYZ fulfills its obligation
on the bond through maturity after 10 years, Steve will make a profit on the annual $20 payments.

3. Convertible Debt Security. A convertible debt security is a security that can be converted into
another security at the option of the issuer and/or the holder. A convertible bond is a type of bond
that can be converted into shares of stock in the issuing company, usually at some pre-announced
ratio. A convertible bond will typically have a lower coupon rate because the holder is also
compensated by the value of the holders ability to convert the bond into shares of stock. In
addition, when it is first issued, the bond is usually convertible into common stock at a substantial
premium to its market value.

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(EXAMPLE) - suppose a company issues a convertible bond at a par value of $10,000. According to
the issuance documents, the investor in the convertible bond can convert it to common stock of the
company at a price of $25 per share (i.e. conversion price). By dividing the par value of the bond by
the conversion price, it's possible to determine that if converted, the bond will result in 400 shares
of the company (i.e., $10,000 $25 = 400 shares).

4.Collateralized Mortgage Obligations (CMO)- A collateralized mortgage obligation (CMO) is a fixed

income security that uses mortgage-backed securities as collateral. Like other structured securities,
CMOs are subdivided into graduated risk classes, called tranches that vary in degree based on the
maturity structure of the mortgages.

When an investor purchases a CMO, he or she purchases some class or tranche of the security
whose risk depends on the maturity structure of the mortgages backing it. These tranches are
usually designated as A, B, C, etc. and increase in degree of risk as the letters ascend.

(EXAMPLE):To illustrate, Class A of a CMO would be the highest risk tranche offering the highest
rate of return based on mortgages that still have a long term until full repayment by the borrowers.
For this reason, they are exposed not only to interest rate and default risk but also to prepayment
risk, the risk that borrowers will pay off the mortgage in advance of the mortgage term (e.g. 15
years, 30 years, etc.). Class A in this CMO will be the first of all of the tranches to absorb losses from
borrowers' failure to make payments. Class A will, however, also be the first to receive money from
prepayments.

By contrast, Class C of a CMO would carry the least risk for the holder, but offer a much lower rate of
return. This is because the mortgages backing it are likely approaching their full repayment, meaning
that the holder is solely receiving interest, and perhaps some principal payments from the
remainder of the mortgage term. For this reason, Class C CMOs will receive little or no returns from
prepayments.

5. Collateralized Debt Obligation (CDO) - A Collateralized Debt Obligation, or CDO, is a synthetic

investment created by bundling a pool of similar loans into a single investment that can be bought or
sold. An investor that buys a CDO owns a right to a part of this pool's interest income and principal.

(EXAMPLE) - A bank might pool together 5,000 different mortgages into a CDO. An investor who
purchases the CDO would be paid the interest owed by the 5,000 borrowers whose mortgages made
up the CDO, but runs the risk that some borrowers don't pay back their loans. The interest rate is a
function of the expected likelihood that the borrowers whose loans make up the CDO will default on
their payments - determined by the credit rating of the borrowers and the seniority of their loans.

CDOs are created and sold by most major banks (e.g. Goldman Sachs, Bank of America) over the
counter, i.e. they are not traded on an exchange but have to be bought directly from the bank.
Securities Industry and Financial Markets Association estimates that US$ 503 billion worth of CDOs
were issued in 2007.

6. Interest Rate Swap. An interest rate swap is an agreement whereby one party exchanges a stream
of interest for the other partys stream of interest. Typically, one party agrees to make payments
that are equivalent to a fixed rate of interest on the specified notional amount in exchange for
payments from the other party that are equivalent to a variable rate of interest (based on a specified
index) on the same notional amount.

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(EXAMPLE) - ABC Company and XYZ Company enter into one-year interest rate swap with a nominal
value of $1 million. ABC offers XYZ a fixed annual rate of 5% in exchange for a rate of LIBOR plus 1%,
since both parties believe that LIBOR will be roughly 4%. At the end of the year, ABC will pay XYZ
$50,000 (5% of $1 million). If the LIBOR rate is trading at 4.75%, XYZ then will have to pay ABC
Company $57,500 (5.75% of $1 million, because of the agreement to pay LIBOR plus 1%).

Therefore, the value of the swap to ABC and XYZ is the difference between what they receive and
spend. Since LIBOR ended up higher than both companies thought, ABC won out with a gain of
$7,500, while XYZ realizes a loss of $7,500. Generally, only the net payment will be made. When XYZ
pays $7,500 to ABC, both companies avoid the cost and complexities of each company paying the
full $50,000 and $57,500.

7.Mortgage-Backed Securities (MBS). A mortgage-backed security is an asset-backed security, the

payments on which are derived from a discrete pool of first-lien mortgage loans.

The security represents an undivided beneficial ownership interest in the pool of assets. The most
basic type of MBS is a simple pass-through security that entitles the holders to receive a pro rata
share of the principal and interest payments on the underlying mortgage loans.

(EXAMPLE)- Bank A specializes in home loans and lends money to home owners who are willing to
collateralize their loan with their home. Normally, Bank A would make its money from the loans by
charging a small interest rate and waiting out the duration of the loan. This is not only risky, but it is
also time consuming, as most mortgages are 30-year loans.

Thus, looking to move some of these mortgages off its books and free up some cash flow, Bank A
bundles hundreds of its mortgages and sells them to an investment bank (Bank I). In this way, Bank A
gets its principal back up front and earns a small amount of interest. Now, when the borrowers pay
their monthly mortgage payments to Bank A, the payments are sent to Bank I because they now
own the rights to the income streams of the mortgages. Bank I then splits the mortgages into
securities that can be sold to individual investors.

With these multiple layers of intermediaries, the market value expands as the profits at each layer
have to be accounted within the market price itself. What essentially reaches the individual investor
is a share of risk (magnified in the course of mortgage transfers) with an expectation of higher
returns that would reflect with the real estate scenario in an economy.

8.Naked Option - A naked option is an uncovered option, i.e., a put option purchased or a call option
written where the seller does not own the underlying security. It is the opposite of a covered option.
Also called an uncovered option, a naked option is a put or call option for which the selling or buying
party does not own the units of the associated underlying security. In the case of a naked put option,
the purchasing party does not own the underlying units; and in the case of a naked call option, the
selling (writing) party does not own the underlying units.

(EXAMPLE) - If an investor writes a naked call option involving 100 units of stock XYZ, the writer does
not actually hold the 100 XYZ units. Likewise, if those same 100 shares are involved in a put option,
the purchasing party does not own them.

9. Put Option -A put option is a financial contract that gives the holder the right (but not the
obligation) to sell the underlying asset at a strike price during a specified period for a premium.
Conversely, the writer of a put option is obligated to buy the underlying asset from the holder at the
strike price upon its exercise at any time prior to the expiration date. European put options differ

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from American insofar as they must be exercised on a specified date rather than at any time before
expiration.

(EXAMPLE) - If a trader purchases a put option contract for Company XYZ for $1 (i.e. $01/share for a
100 share contract) with a strike price of $10 per share, the trader can sell the shares at $10 before
the end of the option period. If Company XYZ's share price drops to $8 per share, the trader can buy
the shares on the open market and sell the put option at $10 per share (the strike price on the put
option contract). Taking into account the put option contract price of $.01/share, the trader will
earn a profit of $1.99 per share.

10.Total Return Swap. A total return swap is a contract whereby a buyer agrees to make payments
that are the equivalent of interest on a specified notional amount in exchange for the right to
receive payments equivalent to any appreciation in the value of an underlying security, index or
other asset, as well as payments equivalent to any distributions made on that asset. If the value of
the asset underlying a total return swap declines over the term of the swap, the buyer may also be
required to pay an amount equal to that decline in value to its counterparty.

(EXAMPLE) - Assume that two parties enter into a one-year total return swap in which one party
receives the London Interbank Offered Rate, or LIBOR, in addition to a fixed margin of 2%. On the
other hand, the other party receives the total return of the Standard & Poor's 500 Index (S&P 500)
on a principal amount of $1 million. If LIBOR is 3.5% and the S&P 500 appreciates by 15%, the first
party pays the second party 15% and receives 5.5%. The payment is netted at the end of the swap
with the second party receiving a payment of $95,000, or ($1 million x 15% - 5.5%).

Assume the S&P 500 falls by 15%, rather than appreciating by 15%. The first party would receive
15% in addition to the LIBOR rate plus the fixed margin. The payment netted to the first party would
be $205,000, or ($1 million x 15% + 5.5%).

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