Structured Products Canadian Annual Derivatives Conference August 17 th -19 th 2005

Why Structured Products? Access to strategies unavailable to Mutual Funds Repackaging of securities Tax benefits Access to offshore securities and funds Access to enhanced manager ‘tool kit’ short selling options derivatives Leverage Exposure to previously unattainable investments Offshore property Hedge Funds

Forms of Structured Products Listed: Income Trusts Split Share Corporations Closed End Funds Flow through LP’s Exchange Traded Funds (ETF’s) Unlisted: Market linked instruments

Listed Structured Products Ending Dec 2004: -$41.5 Billion -3% of TSX -228 products Source: TSX Group Inc.

Listed Structured Products Ending Dec 2004: -SP’s: $9.5B -Corp: $3.2B -IT’s: $2.9B

Source: Investor Economics Unlisted Structured Products Growth yr/yr: ML GICs: -0.5% Linked Notes: 29%

Source: Investor Economics Unlisted Structured Products

Source: Investor Economics Unlisted Structured Products

Principal Protected notes A debt security issued by an agent (Investment manager and backed by a guarantor (usually Schedule I or II bank) Guarantees 100% of principal if held to maturity (a range of 6 to 10 years) At maturity, pays original principal plus appreciation from the underlying ‘linked’ asset. May pay a coupon (variable or fixed) with no correlation between value of this coupon and return of the underlying asset

PPN underlying assets Underlying assets that are ‘linked’ to notes include: Mutual funds Group of funds An index Basket of equities Pools of income trusts Hedge funds Funds of funds Emerging markets Currencies Commodities etc

Source: Investor Economics Growth in PPN’s CAGR since Dec 1999: 70.3%

PPN’s: two approaches 1.Zero Coupon Bond Strip bond with option: (example $100 note) $70 into zero coupon or strip bond $30 into long term option on underlying asset Leverage x option ≈ $100 notional exposure to asset Issues: A Low interest environment requires large portion of the investment to be applied to zero coupon bond May not get leverage on call option to get $100 notional exposure Call option tied to expected volatility of asset (conservative but can be costly) Selling before maturity can be costly as the strip bond is heavily discounted to start.

PPN’s: two approaches 2.Constant proportion portfolio insurance (CPPI) CPPI (a monitoring approach) Two components Underlying investment A guarantee, notionally related to a zero coupon bond that matures at 100% Formula monitors the NAV of the underlying asset against a reference curve or ‘floor’ that increases over time. Starting floor value = cost of zero coupon bond calculated to yield 100 at maturity. Over time, zero coupon bond cost increases. As long as the investment NAV remains a specific distance above this floor (delta), all cash is kept in the investment. Allows for leverage to be applied if NAV gains in value and removed if NAV falls below the delta (dynamic leverage)

CPPI Example: 8 yr term, $100 note At Time 0: Annual yield on 8yr zero coupon bond = % Over 8 years this = 24.5% Cost of zero coupon = $75.50 (floor) rises over time Starting delta (distance between zero coupon cost and 100) = 24.5 To keep $100 in the investment, the NAV of the investment must not fall below 24.5% above the floor.

CPPI De-leveraging begins Knock out guarantee Asset return delta

CPPI: enhancements Some enhancements to the CPPI structure: Lock-ins to periodically crystallize gains above the delta Payouts or coupon payments (return of capital until initial capital amount met) Options on CPPI for offshore exposure within FIE constraints Conversion of income to capital gains through derivatives

Risks Credit rating of guarantor Mitigated by using rated schedule I and II banks Level of participation in underlying asset CPPI investment can be reduced by poor initial performance (de-levered). Harder to get back returns due to lower investment base locked out early (end up sitting in a bond for a few years) (assessment of underlying asset is very important !) Cost of guarantee Driven by interest rates lower interest rates = lower yield = higher cost of guarantee In unlisted PPN’s, the secondary market is at the mercy of guarantor (availability, gates, discount)

Structured Product: Fees Strategy dependant on value of CPPI structure to an investment Fees for guarantee (discounted to pay guarantor) Fees for option Plus trailers, expenses, management fees, front end fees and commissions to investment manager and advisor etc

More information & Acknowledgements TSX Group ( Investor Economics ( Fund Library ( Investment executive ( AIMA ( Various regulators

Thank you Contact details: Andrew Doman Chief Operating Officer Abria Alternative Investments Inc. 20 Adelaide Street East, Suite 300 Toronto, Ontario, Canada M5C 2T6 Tel: Fax: website: