1. De-risking in a Low and Rising Interest Rate Environment
Gary Knapp, CFA, FRM Managing Director, Liability-Driven Strategies Prudential Fixed Income
Please see “Notice Page” in the appendix for important disclosures regarding the information contained herein. The comments, opinions and estimates contained herein are based on and/or derived from publicly available information from sources that Prudential Fixed Income believes to be reliable. We do not guarantee the accuracy of such sources or information. This outlook, which is for informational purposes only, sets forth our views as of this date. The underlying assumptions and our views are subject to change.
November 2011
CONFIDENTIAL – FOR EDUCATIONAL PURPOSES ONLY – NOT FOR FURTHER DISTRIBUTION

2. Key Considerations Is Now The Time To Extend Duration?
Long-term rates are not nearly as low as short-term rates
Treasury curve is unusually steep between intermediate and long-term bonds
Extending to long duration outperforms intermediate bonds in many scenarios
If long rates rise sharply, the effects on equities may be larger than on bonds

3. Steepness of Yield Curve Offers Unique Opportunity
Is Now The Time To Extend Duration?
Steepness of Yield Curve Offers Unique Opportunity
US Treasury curve remains historically steep from intermediate- to long-term maturities, the key maturity range for pension plans
Difference between 10- and 30-year US Treasury yields was 100 bps (as of 9/30/11), well above average yield differential of 30 bps since January 1980
Historically, the curve steepens during periods of accommodative monetary policy and then flattens as the Federal Reserve begins raising short-term rates
Federal Funds Rate and U.S. Treasury Yields
As of September 30, 2011
Yield (%)
Bps
Average Spread
Source of data: Bloomberg. Source of calculations: Prudential Fixed Income.

4. How Extending Duration Affects Asset Portfolio Risk
Current Steepness of Yield Curve Compensates Investors For Extending Now
Extending from an intermediate fixed income portfolio to a long duration will increase portfolio interest rate risk
However, current steepness of the curve allows a long duration strategy to provide a much higher yield, which we believe helps compensate for this additional risk
A plan can now add more than 1.6% yield to its fixed income portfolio by moving from intermediate to long duration strategy
Barclays Aggregate Bond and Long Duration Government/Credit Indices
As of September 30, 2011
Barclays US Aggregate Bond Index
Barclays Long Govt/Credit Index
Yield to Worst (%)
2.35
4.01
Duration (yrs)
4.96
14.21
Quality
Aa1/Aa2
Aa2/AA3
Yield pick-up: 1.66% Duration increase: yrs
Source of benchmark data: Barclays. Source of calculations: Prudential Fixed Income.

5. Two Key Factors: Yield Pickup and Curve Flattening
Long-Term Yield Differential Supports Extending Duration Now
Two Key Factors: Yield Pickup and Curve Flattening
Historic yield pickup: Current yield differential of 166 bps is close to historic levels, offering 95 bps more yield than the 20 year average
Prospect for curve flattening: Yield differential lies 1.6 standard deviations from its historic average suggesting probability of curve flattening is higher than the probability it will continue to steepen
Yield Differential Between Intermediate And Long Duration Strategies Barclays Aggregate Bond Index vs. Long Duration Government/Credit Index
January 1, 1990 to September 30, 2011
Bps
Yield Differential
Current
166 bps
Average
71 bps
Historically high yield differential
Average Yield Differential
Curve would have to flatten 95 bps to return to historical avg.
Extending now to a long duration strategy could provide more attractive returns than continuing to invest in an intermediate strategy over time 
Source of data: Bloomberg. Source of calculations: Prudential Fixed Income.

6. How Changes In Rates and Steepness of the Curve Could Affect Performance
Sample Scenario: Yield Curve Flattens - Short and Intermediate Rates Rise More Than Long-Term Rates
How the Asset Portfolio Would Perform:
Over one-year, intermediate portfolio and long duration portfolio would have similar returns, if long-term interest rates rise about half as much as intermediate-term rates
Over two-year, long duration portfolio would outperform provided intermediate-term rates do not rise by more than +150 bps, and long-term rates do not increase by more than +75 bps
Short and Intermediate Rates Rise More Than Long-Term Rates
Hypothetical Total Return of Intermediate vs. Long Duration Strategies
As of September 30, 2011
Yield Increase (bps)
Annualized Total Return Scenarios (%)
One Year
Two Years
Barclays US Aggregate Bond Index
Barclays
Long Govt/Credit
Index
Barclays Long Govt/Credit Index
+80
+40
-1.6
-1.7
0.4
1.2
+150
+75
-5.1
-6.7
-1.4
-1.3
+300
-12.5
-17.3
-5.2
-6.8
Approximate breakeven points
Reflects the hypothetical yield increase of each index. Source of underlying data: Barclays Capital. Source of calculation: Prudential Fixed Income. For illustrative purposes only. The total return calculations shown are hypothetical and reflect the sum of 1) the beginning yield of the index and 2) the change in value based on the duration of the index and change in the level of interest rates. Yield and duration index data is as of September 30, 2011.

7. Is Now The Time To Extend Duration?
We Believe Extending Duration Of An Existing Fixed Income Strategy Is A Move In The Right Direction
Historically steep yield curve provides a generous yield pick-up
When the Fed begins to tighten, the curve is likely to flatten going forward, giving a long duration strategy the potential to outperform an intermediate strategy
Intervention by governments likely to keep long-term rates range-bound
A sharp rise in long-term rates could be worse for equities than long duration bonds
Corporate spreads likely to tighten as demand from pension plans increases
As of September 30, 2011.

8. Notice
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