1. CMTA Advanced Treasury Workshop Floating Rate Notes, Fixed to Float Securities, Step Down Bonds and Convexity Presented by: Tony Garcia, CFA Vice President Pomona, CA January 31, 2012

2. 1 If you can’t explain it to a six year old, you don’t understand it yourself. -Albert Einstein

3. On the Agenda  Floating Rate Securities  A security where the coupon floats relative to an index  Fixed to Float Securities  A security that has a fixed coupon for a period and then converts to a floating rate security  Step Down Bonds  A callable security where the coupon declines  Negative Convexity  The bane of callable buyers 2

4. Floating Rate Securities

5.  Coupon Floats Relative to Index (Benchmark or Reference rate) Coupon Rate = reference rate (index) +/- quoted margin  Indexes  Fed Funds – Daily Reset  Libor – O/N, 1 Month, 3 Month, 6 Month, 12 Month  CMT – Spread to Constant Maturity Treasury with regular resets  Commercial Paper  Prime Rate  Treasury Bill – 1 Month, 3 Month, 6 Month  TIPS – Inflation Indexed  Inverse Floaters – Where the coupon moves in the opposite direction to the reference rate *You cannot buy these* 4

6. Floating Rate Securities  Issuers  Treasury – TIPS  Agencies – Debentures and Asset Backed  Municipalities  Corporations  Discount Margin  Effective spread to index  Caps and Floor  Cap – The limit to which a coupon can float  Floor – Minimum possible coupon  Collar – When security has both a cap and a floor 5

7. Components Of Pricing  Spread to Index determines coupon  Reset Frequency  Maturity  Change in Basis 6

8. Discount Margin  Discount margin is the inferred change in spread to Index  Price changes to reflect change in market  Price change = PV of change in DM  As with YTM 7

9. Basis Risk  Change in DM to reflect adjustments in market  If credit quality improves DM should decline  If credit quality deteriorates DM will widen  If spreads narrow DM will decline  May also change due to change absolute level of interest rates 8

10. ING BANK Step Up FRN Source: Bloomberg 9

11. ING BANK Step Up FRN Source: Bloomberg 10

12. ING BANK Step Up FRN Source: Bloomberg 11

13. Value To A Portfolio  Lower Duration  Reset frequency lowers effective duration  Lower Price volatility  Yield will move in direction of underlying index 12

14. Berkshire FRN 2/11/13 Reset 3 MO Libor +43 Source: Bloomberg 13

15. Berkshire FRN 2/11/13 Reset 3 MO Libor +43 Source: Bloomberg 14

16. Berkshire FRN and Treasury 2.75% 2/13 BRK FRN 2/13 TSY 2.75 2/13 DATE PRICE YIELD PRICE YIELD 2/11/10 100.000 DM + 43 104.012 1.40 1/11/11 100.905 DM + 13 106.419 0.62 CHANGE +.905 DM -30 +2.407 -0.78 Note: Settlement date held static at 2/11/10 to avoid amortization effect 15

17. Fixed to float securities

18. Fixed to Floating Rate Securities 17  Securities begin with a Fixed Coupon rate for specified period then will switch to a Floating Rate Coupon  May be bulleted or callable  Issued by Agencies and Corporations  Can provide protection against rising rates  Basis shift out of a low volatility environment can be a concern

19. Agency Fixed to Float 18 Source: Bloomberg

20. Agency Fixed to Float – Coupons 19 Source: Bloomberg

21. Corporate Fixed to Float 20 Source: Bloomberg

22. Agency Fixed to Float – Coupons 21 Source: Bloomberg

23. Step down bonds

24. Step Down Callable  Security structure where coupon steps down if bond not called  Likelihood of call is very small  Short term cash flow is the focus 23

25. Source: Bloomberg Step Down Callable 24

26. Step Down Callable – YTC Schedule Source: Bloomberg 25

27. 5 Year Treasury Yield Source: Bloomberg 26

28. One Time Callable Source: Bloomberg 27

29. Agency Bullet Yield Curve Source: Bloomberg 28

30. Step Down Callable OAS Analysis Source: Bloomberg 29

31. Callable Agency OAS Analysis Source: Bloomberg 30

32. Step Down Callable – Comparison YTMOption value Step Down 2.080.59 Callable 2.401.82 Treasury 2.07 Agency Bullet 2.25 31

33. Step Down Callable – Cash Flows 32

34. Convexity

35. Convexity/Negative Convexity  Convexity  A Measure of how curved the price-yield curve is  The second derivative of the price-yield function  Low coupon and long maturity bonds tend to have high convexities  High coupon and short maturity bonds tend to have low convexities  Negative Convexity  Where the rate of change of the price of a bond slows as rates fall  Generally due to embedded option(s) 34

36. Price / Yield Function 35 PRICE YIELD

37. Duration 36 PRICE YIELD

38. Convexity 37 PRICE YIELD { }

39. Convexity Changes 38 PRICE YIELD

40. Negative Convexity 39 PRICE YIELD

41. Negative Convexity 40 PRICE YIELD

42. 12 Month Horizon Return 41 Pricing Date: 01/16/2013 Type: Spot Curve Currency: USD Horizon Months: 12 Reinvestment Rate:.104 IssuerCouponMaturityYTWEff DurConvFieldName-300-200-1000100200300 BULLET0.75001/12/20180.8504.8860.133 Total Return14.2549.8305.5991.555-2.313-6.013-9.553 Ending Price112.950108.547104.337100.31196.46192.77889.253 Ending Avg Life4.000 Ending Eff Dur3.9893.9673.9463.9253.9053.8843.864 Ending Conv0.0900.0890.0880.087 0.0860.085 STEP UP0.70001/30/20180.7002.188-1.406 Total Return0.350 0.5250.547-1.465-4.880-8.463 Ending Price100.000 97.86194.44590.860 Ending Avg Life0.000 3.0003.5004.000 Ending Eff Dur0.000 2.4873.4013.870 Ending Conv0.000 -0.3070.2170.061 CALLABLE1.00001/11/20181.0002.504-1.647 Total Return0.486 0.540-1.753-5.442-8.975 Ending Price100.000 97.24593.55490.019 Ending Avg Life0.000 4.000 Ending Eff Dur0.000 3.3153.8613.842 Ending Conv0.000 -0.4800.0830.084 FNMA 0.70% 1/30/18 QUARERLY CALLS 7/30/13 Coupons: 0.70 to 1/16 0.875 to 7/16 1.0 to 1/17 2.0 to 7/17 3.0 to 1/18 FHLB 1.0% 1/11/18 QUARTERLY CALLS 7/11/13 FHLMC 0.75% 1/12/18 Source: Bloomberg and Bond Edge

43. 12 Month Horizon Return 42 Pricing Date: 01/16/2013 Type: Spot Curve Currency: USD Horizon Months: 12 Reinvestment Rate:.104 IssuerCouponMaturityYTWEff DurConvFieldName-300-200-1000100200300 BULLET0.75001/12/20180.8504.8860.133 Total Return14.2549.8305.5991.555-2.313-6.013-9.553 Ending Price112.950108.547104.337100.31196.46192.77889.253 Ending Avg Life4.000 Ending Eff Dur3.9893.9673.9463.9253.9053.8843.864 Ending Conv0.0900.0890.0880.087 0.0860.085 STEP UP0.70001/30/20180.7002.188-1.406 Total Return0.350 0.5250.547-1.465-4.880-8.463 Ending Price100.000 97.86194.44590.860 Ending Avg Life0.000 3.0003.5004.000 Ending Eff Dur0.000 2.4873.4013.870 Ending Conv0.000 -0.3070.2170.061 CALLABLE1.00001/11/20181.0002.504-1.647 Total Return0.486 0.540-1.753-5.442-8.975 Ending Price100.000 97.24593.55490.019 Ending Avg Life0.000 4.000 Ending Eff Dur0.000 3.3153.8613.842 Ending Conv0.000 -0.4800.0830.084 FNMA 0.70% 1/30/18 QUARERLY CALLS 7/30/13 Coupons: 0.70 to 1/16 0.875 to 7/16 1.0 to 1/17 2.0 to 7/17 3.0 to 1/18 FHLB 1.0% 1/11/18 QUARTERLY CALLS 7/11/13 FHLMC 0.75% 1/12/18 Source: Bloomberg and Bond Edge

44. 12 Month Horizon Return 43 Pricing Date: 01/16/2013 Type: Spot Curve Currency: USD Horizon Months: 12 Reinvestment Rate:.104 IssuerCouponMaturityYTWEff DurConvFieldName-300-200-1000100200300 BULLET0.75001/12/20180.8504.8860.133 Total Return14.2549.8305.599 1.555 -2.313-6.013-9.553 Ending Price112.950108.547104.337 100.311 96.46192.77889.253 Ending Avg Life4.000 Ending Eff Dur3.9893.9673.946 3.925 3.9053.8843.864 Ending Conv0.0900.0890.088 0.087 0.0860.085 STEP UP0.70001/30/20180.7002.188-1.406 Total Return0.350 0.525 0.547 -1.465-4.880-8.463 Ending Price100.000 97.86194.44590.860 Ending Avg Life0.000 3.0003.5004.000 Ending Eff Dur0.000 2.4873.4013.870 Ending Conv0.000 -0.3070.2170.061 CALLABLE1.00001/11/20181.0002.504-1.647 Total Return0.486 0.540 -1.753-5.442-8.975 Ending Price100.000 97.24593.55490.019 Ending Avg Life0.000 4.000 Ending Eff Dur0.000 3.3153.8613.842 Ending Conv0.000 -0.4800.0830.084 FNMA 0.70% 1/30/18 QUARERLY CALLS 7/30/13 Coupons: 0.70 to 1/16 0.875 to 7/16 1.0 to 1/17 2.0 to 7/17 3.0 to 1/18 FHLB 1.0% 1/11/18 QUARTERLY CALLS 7/11/13 FHLMC 0.75% 1/12/18 Source: Bloomberg and Bond Edge

45. Portfolio Comparison – Bullets vs Callables 44 Security detail Portfolio BulletsPortfolio Callables Par$70,000,000Par $70,000,000 Market Value$71,085,000Market Value$70,225,000 Average Life1.328Average Life1.246 YTM0.517YTM0.918 Modified Duration1.31Modified Duration3.32 Effective Duration1.16Effective Duration1.30 Convexity 0.10 Convexity -0.77 Porfolio distribution Source: Bloomberg and Bond Edge

46. Security Shock Testing 45 Source: Bloomberg and Bond Edge

47. Security Shock Testing 46 Source: Bloomberg and Bond Edge

48. Security Shock Testing 47 Source: Bloomberg and Bond Edge

49. Dynamic Cash Flow Shock Testing 48 Source: Bloomberg and Bond Edge

50. - - Douglas Adams I love deadlines. I love the whooshing noise they make as they go by. 49

51. Contact Information 50 Tony Garcia, CFA Vice President MAC A0716-07T 400 Capitol Mall, 7 th Floor Sacramento, CA 95814 Phone: (888) 267-9113 FAX: (916) 442-2750 Email: tgarcia@wellsfargo.comtgarcia@wellsfargo.com

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