Methodology brief Introducing the J.P. Morgan Emerging Markets Bond Index Global (EMBI Global)

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1 Mehodology brief Emerging Markes Bond Index The EMBI Global, which currenly includes 27 counries, has been creaed in response o invesor demand for a broader emerging markes deb benchmark The EMBI Global is a radiional, markecapializaion-weighed index; in addiion, an index ha limis he weighs of larger counries called he EMBI Global Consrained will be produced J.P. Morgan Research will base is emerging markes model porfolio recommendaions on he EMBI Global Daily hisorical index levels are available from December 31, 1993 Overview The J.P. Morgan Global (EMBI Global), which currenly covers 27 emerging marke counries, is our newes and mos comprehensive emerging markes deb benchmark. Included in he EMBI Global are U.S.-dollar-denominaed Brady bonds, Eurobonds, raded loans, and local marke deb insrumens issued by sovereign and quasi-sovereign eniies. Exhibi 1 deails he EMBI Global s counry weighs, as well as is regional weighs, as of July 30, The EMBI Global was creaed in response o invesor demand for a benchmark ha includes a broader array of counries. I expands upon he composiion of is predecessor, he Plus (EMBI + ), by using a differen counry selecion process and admiing less liquid insrumens. Exhibi 1 EMBI Global: Counry and regional composiions Marke capializaion weighs (%) as of July 30, 1999 Ecuador 1.3 Peru 1.3 Colombia 1.1 Morocco 1.1 Greece 1.0 Turkey 0.9 Hungary 0.7 Croaia 0.6 Lebanon 0.6 Souh Africa 0.5 Algeria 0.5 Thailand 0.4 Chile 0.3 Poland 2.7 Malaysia 2.5 Panama 1.9 Bulgaria 1.8 Nigeria 1.8 China 1.6 Coe d Ivoire Philippines 2.9 Russia 6.3 Venezuela 5.6 Souh Korea 7.5 Mexico 15.2 Argenina 20.4 Brazil 19.2 Insead of selecing counries according o a sovereigncredi-raing level, as is done wih he EMBI +, he EMBI Global defines emerging markes counries wih a combinaion of World Bank-defined per capia income brackes and each counry s deb-resrucuring hisory. These wo crieria allow he EMBI Global o include a Lain America Asia Europe Africa Middle Eas

2 page 2 number of higher-raed counries ha inernaional invesors have neverheless considered par of he emerging markes universe. The EMBI Global like he EMBI + will only consider for inclusion emerging markes issues denominaed in U.S. dollars, wih a minimum curren face ousanding of US$500 million and a leas 2½ years o mauriy (a he ime each is added o he index). However, he EMBI Global does no require ha is candidae insrumens saisfy he EMBI + s series of addiional liquidiy ess (a minimum bid/ask price spread and a specific number of inerdealer broker quoes). Insead, he EMBI Global only requires ha easily accessible and verifiable daily prices, eiher from an inerdealer broker or J.P. Morgan source, be available for he given insrumen. The EMBI Global s use of hese pricing crieria resuls in he inclusion of nearly wice as many issues as are in he EMBI +. Two differenly weighed versions of his broader group of bonds are available. The flagship EMBI Global will use a radiional marke-capializaion approach o deermine he weigh of each individual issue, as well as he resuling counry index allocaions. The EMBI Global whose weighs more accuraely represen he marke s supply of index issues is geared oward acive managers of large porfolios and any porfolio ha, regardless of size, faces daily flucuaions in is balance of invesable funds. An alernaive index, he EMBI Global Consrained, limis he weighs of hose index counries wih larger deb socks by only including a specified porion of hese counries eligible curren face amouns of deb ousanding. The EMBI Global Consrained is geared oward managers who face limiaions on he amoun of porfolio exposure hey can ake o individual issuers. In addiion, he EMBI Global Consrained which assigns a larger weigh o less liquid issues from counries wih smaller deb socks may be a more appropriae Exhibi 2 EMBI + vs. EMBI Global: Indices a a glance July 30, 1999 EMBI+ benchmark for managers of smaller, passively-managed porfolios ha are no faced wih flucuaions in heir balances of invesable funds. These invesors should be beer posiioned o deal wih he less liquid composiion characerisics of he EMBI Global Consrained. Why creae an expanded index? Since he EMBI + s inroducion in July 1995, he populaion of emerging markes sovereign and quasisovereign issuers has significanly expanded. Though he issues from hese counries have hisorically me he EMBI + s minimum issue size requiremen of US$500 million, hey did no mee is sringen liquidiy crieria and so were excluded. The EMBI Global, which uses relaxed insrumen selecion crieria, incorporaes coverage of his growing porion of he emerging markes deb universe. As shown in Exhibi 3, since heir sar daes boh he EMBI Global and EMBI Global Consrained have exhibied risk and reurn characerisics similar o ha of he EMBI +. However, i is imporan o noe ha he Exhibi 3 Hisorical oal reurn performance comparison Based on monhly daa, as of July 30, 1999 EMBI Global EMBI Global Consrained EMBI YTD Cumulaive reurn Average annual reurn Reurn volailiy EMBI Global Number of counries Number of insrumens Marke capializaion US$127 billion US$169 billion Counry admission requiremens Mus be raed BBB-/Baa3 or lower by boh S&P and Moody s Classified as having low or middle per capia income by he World Bank, or Has resrucured exernal or local deb in pas 10 years, or Currenly has resrucured exernal or local deb ousanding General insrumen admission requiremens US$500 million minimum face amoun ousanding, and US$500 million minimum face amoun ousanding, and A leas 2 1/2 years unil mauriy (when added o index), and A leas 2 1/2 years unil mauriy (when added o index), and Mus pass series of liquidiy ess (a minimum bid/ask price Daily price - eiher from an ouside or J.P. Morgan source - mus be available and a specific number of inerdealer broker quoes)

3 page 3 EMBI Global s broader se of counries conains selec, less volaile invesmen opporuniies ha, in he pas, have provided emporary safe havens during marke downurns. Counry and insrumen selecion process We adhere o a sric se of rules for selecing counries and insrumens for inclusion in he EMBI Global. Defining he universe of eligible counries Iniially, wo crieria deermine wheher a counry is defined as an emerging marke and, herefore, can be considered for inclusion in he EMBI Global. Firs, a counry mus be classified as having a low or middle per capia income by he World Bank for a leas one of he pas hree years, based on daa lagged one year. Our curren source for hese classificaions (presenly, any counry wih a per capia income less han US$9,635) is he World Bank publicaion, Global Developmen Finance. Published annually, his repor reflecs per capia income brackes as of he previous year s close. Second, regardless of heir World Bankdefined income level, counries ha eiher have resrucured heir exernal or local deb during he pas 10 years or currenly have resrucured exernal or local deb ousanding will also be considered for inclusion in he index. Using hese wo crieria generaes a universe of 150+ counries ha can be considered for inclusion in he EMBI Global. Insrumen selecion process Once his universe of emerging markes counries has been defined, he eligible insrumens from hese counries mus be seleced. Insrumens ha saisfy all he following defined crieria will be eligible for inclusion in he EMBI Global: 1) Issuer ype classificaion; 2) Currency denominaion; 3) Curren face amoun ousanding; 4) Remaining ime unil mauriy; 5) Selemen mehod; 6) Quanifiable source of cash flow reurn; and 7) Quoed price availabiliy Issuer ype classificaion The EMBI Global conains only hose bonds issued by sovereign and quasi-sovereign eniies from indexeligible counries. Issuers are classified as quasi-sovereign if he sovereign has explicily guaraneed he issuer or is is majoriy shareholder. Currency denominaion From he lis of sovereign and quasi-sovereign deb insrumens from index-eligible counries, only hose insrumens denominaed in U.S. dollars are considered for inclusion. Hisorically, he universe of emerging markes exernal deb has seen is mos liquid issues denominaed in U.S. dollars. A a fuure dae, non-u.s. dollar deb, specifically euro-denominaed issues, will be reconsidered for inclusion in he EMBI Global. Curren face amoun ousanding The lis of U.S. dollar-denominaed sovereign and quasisovereign issues from index-eligible counries is narrowed furher by only considering issues wih a curren face amoun ousanding of US$500 million or more. If an issue s curren face ousanding falls below his requiremen due o eiher a deb reiremen by he sovereign or he amorizaion of principal he issue will be removed from he index a he nex monh-end rebalancing dae. The reverse also holds rue. Exising issues ha, hrough reopenings, increase in size o saisfy our minimum curren face ousanding requiremen are hen considered for inclusion in he EMBI Global. Time unil mauriy Of he issues wih a leas a curren face amoun ousanding of US$500 million, only hose insrumens wih a leas 2½ years unil mauriy are considered for inclusion. Once added, an insrumen may remain in he EMBI Global unil 12 monhs before i maures. On he monh-end preceding his anniversary, he insrumen is removed from he EMBI Global. Selemen mehod Insrumens in he EMBI Global mus be able o sele inernaionally (eiher hrough Euroclear or anoher insiuion domiciled ouside he issuing counry). Quanifiable source of cash flow reurn J.P. Morgan reserves he righ o exclude from he composiion of he EMBI Global any deb insrumen ha i considers o have a cash flow srucure from which a verifiable daily reurn canno be calculaed. Quoed price availabiliy The final requiremen is ha an issue s bid and offer prices be available on a daily and imely basis eiher

4 page 4 from an inerdealer broker or J.P. Morgan. The lack of availabiliy of such prices prevens he addiion of a new issue o he index. In he case of he curren EMBI Global issues, if reliable prices for an issue become unavailable during a monh, i is removed from he index a is nex monh-end rebalancing dae. Once an issue is removed, i will no be reconsidered for inclusion in he index during he nex 12 monhs. As shown in Exhibi 2, he EMBI Global conains a oal of 27 counries 11 more han he 16 currenly in he EMBI +. In addiion, he EMBI Global conains 128 insrumens 60 more han he EMBI + s 68. These counry and insrumen selecion crieria generae a composiion for he EMBI Global ha is significanly differen han ha of he EMBI + (Exhibi 4). Exhibi 4 EMBI + vs. EMBI Global: Counry weighs by region Marke capializaion weighs (%) as of July 30, 1999 LATIN AMERICA EMBI+ EMBI Global Argenina Brazil Chile Colombia Ecuador Mexico Panama Peru Venezuela ASIA Timing of he addiion of new issues A new issue ha mees he EMBI Global s admission requiremens is added o he index on he firs monhend business dae afer is issuance, provided is issue dae falls before he 15 h of he monh. A new issue whose issue dae falls on or afer he 15 h of he monh is added o he index on he las business day of he nex monh. The only excepion o his rule is a new issue ha is released as par of a deb exchange program. For example, assume a counry exchanges a porion of is ousanding Brady deb for a new issue afer he 15 h of he monh. A he monh-end rebalancing dae immediaely following his even, he amoun of deb reired in his exchange would be removed from he EMBI Global, and he new issue would be added o he index (provided official exchange resuls are made available in a imely manner) China Malaysia Philippines Souh Korea Thailand EUROPE Bulgaria Croaia Greece Hungary Poland Russia Turkey AFRICA AND MIDDLE EAST Exhibi 5 indicaes he daes on which he EMBI Global s curren counries were added and deails he differen insrumen ypes conained in each counry s composiion Algeria Coe d Ivoire Lebanon Morocco Nigeria Souh Africa

5 page 5 Exhibi 5 EMBI Global: Counry addiion daes and insrumen-ypes by region July 30, 1999 Insrumen ypes Dae of enry Eurobonds Brady-syle Loans Domesic Lain America Argenina December 1993 Brazil December 1993 Chile May 1999 Colombia February 1997 Ecuador December 1993 Mexico December 1993 Panama December 1993 Peru December 1993 Venezuela December 1993 Asia China March 1994 Malaysia Ocober 1996 Philippines December 1993 Souh Korea December 1993 Thailand May 1997 Europe Bulgaria December 1993 Croaia Augus 1996 Greece January 1997 Hungary January 1999 Poland December 1993 Russia December 1993 Turkey June 1996 Africa Algeria March 1999 Coe d Ivoire April 1998 Morocco December 1993 Nigeria December 1993 Souh Africa December 1994 Middle Eas Lebanon April 1998 Index weighing mehods EMBI Global uses he radiional approach The weigh of each insrumen in he EMBI Global our flagship index is deermined by dividing he issue s marke capializaion by he oal marke capializaion for all insrumens in he index. The resul represens he weigh of he issue expressed as a percenage of he EMBI Global. Counry weighs for he EMBI Global are easily calculaed by aggregaing he weighs of he insrumens for each counry. The marke capializaion of each issue is calculaed by muliplying is face amoun ousanding by is bid-side selemen price. Face amouns ousanding for each issue are updaed a each monh-end in order o reflec marke evens such as reopenings or buybacks ha have increased or decreased he issue s available supply. EMBI Global Consrained uses a unique approach Since he EMBI Global Consrained uses he same counry and insrumen selecion process as he EMBI Global, he lis of issues conained in boh indices is always he same. The monh-end addiion and removal of index issues occur simulaneously for he EMBI Global and EMBI Global Consrained. Where he EMBI Global and EMBI Global Consrained differ is in he porions of each issue s curren face amoun ousanding used in heir respecive calculaions of marke capializaions. While he EMBI Global uses he oal curren face amoun ousanding of each issue, he EMBI Global Consrained uses only a cerain porion of he curren face amoun ousandings for insrumens from counries wih larger deb socks. In effec, he EMBI Global Consrained limis (or consrains) he curren face amoun allocaions of he bonds in he EMBI Global. A similar effec could have been achieved by imposing a maximum index weigh for each counry (for example, 20%), bu such a cap creaes difficulies for benchmarked invesors. An invesor rying o remain neural o a weigh-capped benchmark would need o consanly rebalance his or her porfolio (and incur he resuling ransacion coss) as daily price flucuaions pushed he porfolio s counry weighs above or below he benchmark s fixed weighs. Adjusing he admissible curren face amoun allocaions raher han seing a specific weigh cap sill allows he EMBI Global Consrained o limi a counry s weigh, while mainaining he reinvesmen process characerisic of radiional marke-capializaionweighed indices. This is desirable since, barring composiion changes, a porfolio ha replicaes he index s bond allocaions naurally rebalances iself as asse prices drif. In addiion, he EMBI Global Consrained s counry weighs are kep wihin a desirable range wihou he need o perform forced rebalancings if a counry s weigh drifs above a prese capped weigh. How he EMBI Global Consrained works The EMBI Global Consrained s bond allocaion calculaion process sars wih each EMBI Global counry s curren face amoun ousanding of deb. The following inclusion schedule is applied o hese amouns o deermine he consrained amouns eligible for inclusion in he EMBI Global Consrained.

6 page 6 From each counry s oal EMBI Global eligible deb sock, he EMBI Global Consrained includes: 1) 100% of he firs US$5 billion of he eligible deb sock; 2) 75% of he eligible deb sock ha exceeds US$5 billion bu does no exceed US$10 billion; 3) 50% of he eligible deb sock ha exceeds US$10 billion bu does no exceed US$15 billion; 4) 25% of he eligible deb sock ha exceeds US$15 billion bu does no exceed US$25 billion; 5) 10% of he eligible deb sock ha exceeds US$25 billion bu does no exceed US$35 billion; and 6) 0% of he eligible deb sock ha exceeds US$35 billion. For example, counry A in he EMBI Global has US$50 billion of deb, broken down ino five separae bond issues. Applying he consraining seps described above o his oal eligible deb sock resuls in he following: Curren Percen face amoun eligible Resul Amoun ha is US$5 billion $5.00 x 100% $5.00 Amoun ha is > US$5 billion, bu US$10 billion 5.00 x 75% 3.75 Amoun ha is > US$10 billion, bu US$15 billion 5.00 x 50% 2.50 Amoun ha is > US$15 billion, bu US$25 billion x 25% 2.50 Amoun ha is > US$25 billion, bu US$35 billion x 10% 1.00 Amoun ha is > US$35 billion x 0% 0.00 Toal eligible Consrained deb sock: $50.00 amoun: $14.75 Percenage of oal deb sock eligible for inclusion: 29.50% As shown in he able above, he EMBI Global Consrained would only include US$14.75 billion of counry A s US$50 billion EMBI Global allocaion. In effec, only 29.5% (US$14.75 billion divided by US$50 billion) of counry A s EMBI Global allocaion is eligible for inclusion in he EMBI Global Consrained. The nex sep in he consraining process is o deermine wha porion of each of counry A s five bonds should be included in he EMBI Global Consrained. Applying counry A s inclusion percenage of 29.5% o he curren face allocaion of each bond resuls in he following insrumen allocaions: Insrumen Resuling curren Percenage consrained Insrumen # face amoun eligible face amoun 1 $5.00 x 29.50% $ x 29.50% x 29.50% x 29.50% x 29.50% 0.59 Toal eligible Consrained deb sock: $50.00 amoun: $14.75 In he nex able, his same process is applied o counry B, which has only US$3 billion of eligible deb sock, broken down ino five separae bond issues, in he EMBI Global. The resuls are he following: Curren Percen face amoun eligible Resul Amoun ha is US$5 billion $3.00 x 100% $3.00 Amoun ha is > US$5 billion, bu US$10 billion 0.00 x 75% 0.00 Amoun ha is > US$10 billion, bu US$15 billion 0.00 x 50% 0.00 Amoun ha is > US$15 billion, bu US$25 billion 0.00 x 25% 0.00 Amoun ha is > US$25 billion, bu US$35 billion 0.00 x 10% 0.00 Amoun ha is > US$35 billion 0.00 x 0% 0.00 Toal eligible Consrained deb sock: $3.00 amoun: $3.00 Percenage of oal deb sock eligible for inclusion: % As shown in he able above, he EMBI Global Consrained would include he full US$3 billion of he counry B s eligible deb. Since counry B has such a small curren face amoun ousanding of eligible deb, 100% of counry B s oal EMBI Global insrumen allocaions would also be eligible for inclusion in he EMBI Global Consrained. Deermining insrumen and counry weighs Once hese insrumen allocaions are derived for each counry, he curren selemen price for each insrumen is applied o is EMBI Global Consrained s allocaion o calculae he marke capializaion of each issue in he index. The weigh of each insrumen in he EMBI Global Consrained is hen deermined by dividing is marke capializaion by he oal marke capializaion for all of he EMBI Global Consrained s insrumen allocaions. The resul represens he weigh of each issue expressed as a percenage of he EMBI Global Consrained. By allocaing heir porfolios according o hese exac insrumen weighs, and accouning for coupon reinvesmens and index insrumen allocaion changes, invesors can replicae he performance of he EMBI Global Consrained. Counry weighs for he index are easily calculaed by aggregaing he weighs of he insrumens for all counries. Causes of EMBI Global Consrained rebalancings Since EMBI Global Consrained insrumen allocaions are linked o he oal curren face amoun of deb sock conained in he EMBI Global, any even ha affecs his amoun also riggers a recalculaion of he EMBI Global Consrained s insrumen allocaions. Among he evens ha would rigger his recalculaion are he following: 1) The addiion of an insrumens o he EMBI Global; 2) The deleion of an insrumen from he EMBI Global;

7 page 7 3) An increase in he curren face ousanding of an index insrumen due o a reopening or he capializaion of a coupon as principal; and 4) A decrease in he curren face ousanding due o a buyback or he amorizaion of principal. Adjusmens o he EMBI Global Consrained s insrumen allocaions resuling from he above evens will only be performed on he monh-end rebalancing daes. Impac of his process on counry weighs While he EMBI Global and EMBI Global Consrained boh always conain he same lis of deb insrumens, he EMBI Global Consrained s insrumen allocaion consraining process generaes insrumen and counry weighs ha are differen han hose of he EMBI Global. Counries wih large curren face amouns ousanding of index-eligible deb will have heir EMBI Global Consrained insrumen allocaions and, hus, index marke capializaion weighs reduced relaive o he EMBI Global by he above-described allocaionconsraining process. Conversely, counries wih relaively small curren face amouns ousanding of oal eligible deb will have a larger marke capializaion weigh in he EMBI Global Consrained han in he EMBI Global, since heir insrumen allocaions will no be reduced as much by his process. Exhibi 6 compares he EMBI Global Consrained s regional weighs o hose of he EMBI+ and EMBI Global. A comparison of he counry weighs for hese hree indices appears in Exhibi 7. Exhibi 6 EMBI Global Consrained: Comparison of index regional weighs o hose of oher indices Marke capializaion weighs (%) as of July 30, 1999 Exhibi 7 EMBI Global Consrained: Comparison of index counry weighs by region o hose of oher indices Marke capializaion weighs (%) as of July 30, 1999 LATIN AMERICA EMBI+ EMBI Global EMBI Consrained Argenina Brazil Chile Colombia Ecuador Mexico Panama Peru Venezuela ASIA EUROPE China Malaysia Philippines Souh Korea Thailand Bulgaria Croaia Greece Hungary Poland Russia Turkey EMBI+ EMBI Global EMBI Consrained AFRICA AND MIDDLE EAST Lain America Europe Asia Africa Middle Eas Algeria Coe d Ivoire Lebanon Morocco Nigeria Souh Africa

8 page 8 Daily producion of he EMBI Global The EMBI Global is produced every business day of he year. Business days are based on he U.S. bond marke calendar se by he Emerging Markes Traders Associaion (EMTA). Pricing on regular business days The insrumen prices used in he official closing calculaion of he EMBI Global are capured as of 3:00 p.m. EST. The preferred source for hese prices are inerdealer broker screens. For index insrumens no available on hese screens, price quoes by J.P. Morgan raders are colleced as close as possible o 3:00 p.m. EST. These J.P. Morgan rader prices will coninue being used unil reliable inerdealer broker screen prices become available. If alernae nonbroker pricing becomes available, i will be evaluaed for is qualiy and considered for use in he calculaion of he EMBI Global s resuls. Early closes When he U.S. bond marke closes early, ypically before marke holidays or when EMTA recommends an early close, prices of EMBI Global insrumens are capured a he laes possible ime o reflec an acive closing marke. Where o find he EMBI Global Daily EMBI Global resuls can be found in he following places: MorganMarkes (morganmarkes.com): Conains downloadable files of daily counry and insrumen reurns, saisics, and composiions, as well as daa series of hisorical index levels and sovereign spreads; Reuers: Page EMBI01 offers a direcory of resuls for all J.P. Morgan emerging markes bond indices; Bloomberg: Page JPMX will soon offer EMBI Global resuls; and J.P. Morgan s monhly Emerging Markes Bond Index Monior conains index reurns, saisics, and composiion updaes for all of our emerging markes indices.

9 page 9 Appendix: Insrumen and index oal reurn calculaions The following descripion of our mehodology for calculaing reurns (oal, price, and ineres reurns) is divided ino wo broad secions. Secion I describes single-insrumen reurns. Secion II describes index oal reurns. The oal reurn calculaion for a single insrumen is a means of represening he economic benefi of holding he specific securiy. In is simples form, i is based on he cash in/cash ou noion i.e., wha is paid for he securiy a he iniial purchase versus wha is received a is sale. Of course, mos fixed income securiies pay some form of coupon along he way, and some pay amorizaions. For he calculaion of individual insrumen oal reurns, his cash is reinvesed in he insrumen when received. However, when he insrumen is par of a porfolio whose allocaions are based on marke capializaion (in he case of he EMBI Global or he EMBI Global Consrained), he use of his marke capializaion weighing scheme in effec causes his cash o be proporionaely reinvesed in he oher insrumens ha make up he porfolio. The means of calculaing he oal reurn on a baske conaining various insrumens is an exension of he single-insrumen oal reurn framework. To hold a passive porfolio, one would buy he insrumens in he same proporions in which hey comprise he EMBI Global or EMBI Global Consrained. In he case of he EMBI Global, each proporional amoun is a funcion of boh he amoun of he insrumen ousanding (based on publicly available informaion) and is selemen price. These wo facors, when muliplied ogeher, equal he asse s marke capializaion. The EMBI Global Consrained uses a similar approach, wih one excepion: For each counry wih a larger deb sock, a smaller amoun of each of is insrumen face amouns ousanding is added o he porfolio. I. Single-insrumen reurn The oal reurn on a performing insrumen is measured from one rade day o he nex using he following generalized equaion: ESVs() + C v() + AM v() FXi, (1) r 1 ESV FX s( 1) i, 1 This equaion capures he hree main componens of a fixed income asse s value: price, cash flow (coupon and/or amorizaion) and currency. These componens are represened by: ESV s() Effecive selemen value; primarily a funcion of he effecive selemen price bu also of he ex-coupon and ex-amorizaion rules [see equaion (2) below] C v() AM v() FXi, v() s() If applicable, he coupon paymen o which a holder on rade dae is eniled on value dae v(); deermined by he insrumen srucure, ex-coupon convenions, and holiday calendar If applicable, he amorizaion o which a holder on rade dae is eniled on value dae v(); deermined by he insrumen srucure, ex-amorizaion convenions, and holiday calendar Foreign currency exchange rae for currency i measured in U.S. dollars per uni of foreign currency. Since he EMBI Global and EMBI Global Consrained currenly conain only U.S. dollar-denominaed insrumens, currency does no conribue o he indices daily reurns. However, should non-u.s. dollar-denominaed issues be added o hese indices on a fuure dae, our reurn calculaion will appropriaely incorporae day-o-day currency rae flucuaions. Trade dae; all index insrumens rade on a New York holiday calendar Value dae for rade dae ; dae used o calculae accrued ineres, which usually, bu no always, coincides wih he selemen dae Selemen dae for rade dae ; dae on which cash ransacion occurs The effecive selemen value can be calculaed as follows: (2) ESV s() ESPs() + xc v() + xam v()

10 page 10 where: ESPs() xcv() C L Effecive selemen price, which is he price paid for a bond ha is raded on rade dae and seled on selemen day s(). The selemen dae is deermined by he selemen convenion of he bond and holiday calendar for he selemen convenion; in shor, he amoun of money, including accrued ineres, ec., owed a he selemen dae. Ex-coupon placeholder; in some markes, marke convenion designaes a dae ha begins an ex-period, ending on he coupon paymen dae, during which a seller of he bond is eniled o keep he upcoming coupon. This experiod is usually 30 days. In effec, he coupon is sripped from he bond, such ha he curren buyer is no longer buying he righs o he coupon, and herefore he ESP paid by he buyer should be reduced by he amoun of he foregone coupon. For he oal reurn, however, i is imperaive o mainain he coninuiy of he raded asse i.e., he bond should be reconsiued o is cum-paymen before he ex-srucure. To do his, we accoun for he value his coupon represens o he seller via an ex-coupon placeholder. Inuiively, he placeholder is an amoun represening he value of he nex coupon discouned o he selemen dae of he ransacion and is calculaed as: C xc v() (1 + L ) ds, 360 Coupon amoun o be paid a he end of he experiod One-monh Libor, used as he cash rae for he discouning oal reurn formula and effecively cease o exis when he ex-period elapses. Alhough his equaion is sufficien for he generalized concep of oal reurn, complexiies sem from he deerminaion of he effecive selemen price and he reamen of inerim cash flows. Therefore, below we describe he differences beween insrumen ypes, hen show how hese differences are incorporaed ino he generalized equaion. Effecive selemen prices, ESPs() Effecive selemen price is he insrumen s selemen price - i.e., he amoun of money owed a selemen. ESP calculaions ranslae he quoed price ino his selemen price, aking ino accoun appropriae quoaion convenions and selemen pracices. The quoaion and selemen of foreign-currency bonds in he emerging markes currenly follow guidelines se by hree differen groups. Brady bonds and Eurobonds follow sandard inernaional selemen, se by he Inernaional Securiies Markes Associaion (ISMA). Argenine domesic bonds follow CNV (he local securiies regulaor, analogous o he U.S. SEC) guidelines. Price quoing convenions are overseen, bu no se by, he Emerging Markes Traders Associaion (EMTA); EMTA members also agree upon rading and selemen pracices for loans. As a resul, here currenly are hree selemen pracices used for insrumens in he EMBI Global: sandard inernaional selemen, Argenina local selemen, and loan selemen. The sandard inernaional selemen period was seven calendar days hrough June 1, 1995, and became hree business days on June 7, Argenine domesic selemen is hree business days. Loan selemen follows an EMTA prescribed bach selemen process, whereby rades execued during specified ime periods all sele on single pre-deermined selemen daes. d s, xam v() Number of days from selemen o he nex coupon Ex-amorizaion placeholder; his concep is compleely analogous o he ex-coupon placeholder and is calculaed in he same way: AM xam v() ds, 360 (1+ L ) The ex-coupon and ex-amorizaion placeholders are carried in boh he numeraor and he denominaor of he Two ypes of price-quoing disincions apply: he clean versus diry pricing convenion and he curren versus original face pricing convenion. Clean vs. diry quoe convenions The clean-diry disincion refers o wheher an insrumen s quoed price is inclusive of accrued ineres or no. Since he effecive selemen price refers o all money paid a selemen, if a bond is quoed clean, he accrued ineres hrough he value dae owed a selemen mus be added o he insrumen s price.

11 page 11 Curren face vs. original face value quoe convenions The curren face-original face value disincion applies o amorizing and capializing bonds; i refers o wheher a bond s quoed price is for a curren face amoun of 100 or for he original face value of he bond, which may reflec he fac ha he insrumen has amorized o an amoun less han 100 or has capialized o an amoun greaer han 100. Since effecive selemen price refers o he money acually paid a selemen, which is based on he curren ousanding face value of he bond, an adjusmen is made o he bond s quoed price on a curren-face basis o adjus i o an original-face basis. Exhibi 8 shows he pricing convenions of insrumens in he EMBI Global. Exhibi 8 Price quoing convenions for EMBI Global insrumens Curren Face Original face Clean (wihou accrued ineres) Diry (wih accrued ineres) Bradys, Euros, Moroccan Tranche A Russian Principal Noes and IANs Argenine local marke, Nigerian P- Noes adjusmen a selemen is made via he B v() scalar. This scalar is an imporan variable because i adjuss oher variables affecing he effecive selemen price. Accrued ineres, for example, is normally compued on a cash basis (i.e., coupon rae x day coun), ignoring he curren balance of he bond. Here, again, he scalar is used o adjus he accrued ineres for he balance on he bond. Because he balance scalar is deermined independenly (i.e., i is based solely on he cash flow srucure and quoing convenions for he bond), i can be used o scale all oher variables. The remainder of his descripion assumes ha all non-price variables have been appropriaely adjused and, herefore, defined on an original-face basis. Wih hese conceps in mind, we can generalize he equaion for he effecive selemen price of performing insrumens as follows: (3) where: ESP s() bp + CO AC Q v() { if CO 1, B, if CO 0,1} bp Q v() + CD AI v() For example, a bond ha is rading a par bu has jus amorized 10% would rade a a price of 100 on a curren-face basis, bu a a price of 90 on an originalface basis. Also, a bond ha is rading a par and has jus capialized 10% would rade a 100 on a currenface basis and 110 on an original-face basis. The adjusmen from a curren-face o an original-face basis is achieved by using a balance scalar, B v(), which keeps rack of he remaining balance of a bond afer capializaions and amorizaions. For bonds ha have amorized from par, he balance scalar will be beween 0 and 1, saring a 1 a issue and decreasing o 0 a he final amorizaion (mauriy) of he bond. For bonds ha capialize, he number rises saring a 1, as deermined by he capializaion raes of he bond. This balance scalar sricly follows he quoing convenions of a bond and is no necessarily relaed o he balance of ousanding bonds as racked by an issuer. For example, in he case of bonds ha rade wih an experiod for amorizaions, he ex-balance follows he same convenion. If he bond goes ex-amorizaion 30 days before he coupon, on ha dae he seller reains he righ o he coupon; herefore, he effecive selemen price is lowered (jumps down) by he amoun of he amorizaion, since he buyer is no longer eniled o i. For a bond rading on a curren-face basis, his Q bp CO B v() AC v() Bid price of a bond according o he quoing convenions of he bond s marke; oal reurn is calculaed on he bid side so as o represen he cash ou value of he bond on a given day Curren face/original face value indicaor: 1 Bond quoed on a curren-face basis (i.e., needs scaling if applicable); and 0 Bond quoed on an original-face value basis Face balance scalar used o adjus for principal balance due, as deermined by he cash-flow srucure, and selemen and ex-balance convenions Accrued capializaion; for bonds ha capialize and are quoed on a curren-face basis, an adjusmen is made a selemen for he porion of he nex capializaion ha is no included in he quoed price. Since capializaion is a paymen for principal (unlike accrued ineres, which is a paymen for ineres), he accrued capializaion, AC, is muliplied by he quoed price; AC is deermined analogously o accrued ineres (i.e., capializaion rae x day coun convenion)

12 page 12 CD AI v() Clean/diry indicaor: 1 Bond quoed on a clean basis; and 0 Bond quoed on a diry basis Curren period s coupon rae x day coun convenion; his is calculaed up o, bu excluding, he value dae, v(). Alhough convenions covering accrued ineres calculaions can be generalized, excepions do apply. Selemen and ineres calculaions EMBI Global calculaions ake ino accoun accrued ineres convenions, selemen convenions, and ex-coupon/ ex-amorizaion convenions of each securiy and marke. Day-coun basis In general, he day-coun basis will depend on wheher a bond has a fixed or floaing rae. For fixed-rae bonds, i is usually 30/360, and for floaing-rae bonds, i is usually eiher acual/360 or Treasury acual/acual. Excepions exis, which apply o cerain Brady bonds. Coupon paymen Depending upon he specific deb insrumen, coupons can be scheduled monhly, quarerly, semiannually, or annually. How he coupon end-of-period and pay daes are se vary from bond o bond. Several convenions apply o siuaions in which he end of a coupon s period falls on a weekend or holiday, as defined by EMTA. These convenions are deailed in Exhibi 9. Exhibi 9 End-of-period convenions If a scheduled end-of-period (EOP) dae falls on a weekend or holiday, he end of period: EOP/Pay 1 EOP/Pay 2 EOP/Pay 3 EOP/Pay 4 Remains on ha dae, and he acual pay dae is moved o he nex business day. And he acual pay dae are moved o he nex business day. And he acual pay dae are moved o he nex business day, unless ha pushes hem o he nex calendar monh, in which case hey are moved o he preceding business day. And he acual pay dae are moved o he nex business day, and all subsequen ends of periods are benchmarked from ha day. EOP/Pay 5 All hybrid cases of 1 4. Coupon accrual Generally, ineres accrues from he previous coupon dae (inclusive) o he selemen dae (exclusive). If a bond rades ex-coupon, negaive accrued ineres will accrue from he ex-dae o he coupon dae. Cash reinvesmen Since coupon income and amorizaion paymens on performing insrumens are reasonably cerain, reinvesmen is done on he dae on which he value dae for he rade capures he nex cash paymen. This allows he invesor o affec he reinvesmen rade such ha, when he rade seles, he cash paymen is available. Price and ineres reurn Price reurn is he componen of oal reurn ha follows jus he price movemen. Inuiively speaking, i is he original-face, clean-priced bond s reurn, P(o,c). This bond s reurn is calculaed using variables already defined: O,C Q (4) P { 1, bp if CO Bv(),if CO 0,1} + xam { if CD 0, AI, if CD 1,0} v() V() Price reurn, adjused for currency, hen is: O,C P + AMv() FXi, (5) Pr 1 O,C P FX -1 i,-1 + CO AC v() bp Finally, ineres reurn is simply a residual of oal reurn and price reurn: (6) r ir Pr + 1 Treamen of non-performing insrumens In he even of an unexpeced delay of or defaul on a paymen, he specific cash flow would no be recognized unil he paymen is acually received. The calculaion of an individual non-performing insrumen s reurn and he resuling index reurn would follow he selemencash flow enilemen convenion se by eiher EMTA or a similar marke rade group. Currenly, wo insrumens in he EMBI Global are classified as non-performing asses, he Russian Principal Noes and Ineres Arrears Noes (IANs). A he ime of non-paymen, EMTA recommended ha marke paricipans begin quoing prices for hese insrumens wih all accrued and unpaid ineres for free. In effec, prices for hese insrumens which had previously been quoed on a clean, curren-face basis are now quoed on a diry curren face basis. Using he oal reurn calculaion deailed in Equaion 1, we see Q

13 page 13 ha he daily oal reurns for hese insrumens equal he daily percenage price changes in hese quoed prices. Any cash flow-relaed reurn has been eliminaed due o he paymen defaul. A defaul will no force he removal of he affeced insrumen from he EMBI Global. As long as he affeced insrumen coninues o saisfy our inclusion crieria, i will no be removed from he index. Impac of deb resrucuring on index composiion If a non-performing asse in he EMBI Global is rescheduled, we expec ha he index s holdings would be valued according o he marke s expecaions of he asses (eiher new bonds or cash) ha a credior would receive in he resrucuring process. Our bes model for his process is he one used o value he EMBI + s (as well as he EMBI Global s) non-performing loan posiions as hey were convered o performing bonds hrough he Brady resrucuring era of he lae 1980s and 1990s. From he ime preceding he announcemen of he erms of he Brady exchange unil he issuance of new performing Brady bonds, daily valuaions of our index s holdings of non-performing insrumens were performed using one of hree verifiable sources: 1) Execuable marke prices for he given insrumen assuming direc selemen; 2) Execuable marke prices for he given insrumen assuming selemen on a paricipaion basis; or 3) When-and-if-issued marke prices for he new performing bonds and a discoun value of cash expeced o be received in he deb resrucuring, creaing a hybrid value for he insrumen. Given ha none of he EMBI Global s currenly nonperforming insrumens have enered ino a resrucuring process, we are able o price he index s posiions using daily execuable marke prices assuming direc selemen. For a more deailed example of how he valuaion process was done for pas index holdings of non-performing loans pending a Brady resrucuring, see Plus (EMBI+): Mehodology, July 12, 1995, pages 5 8. II. Index oal reurn To compue a daily index value, we need o know he following: 1) The lis of insrumens o be included and heir amouns ousanding; 2) The daily oal reurn of each insrumen; and 3) The weigh of each insrumen as of he prior business day s close. The firs facor, he lis of insrumens and amouns ousanding, comprises parameers ha are exogenous o he oher facors and, herefore, changes o i should no resul in changes in value of he index. These rebalancing evens are done o he index on he las business day of each monh, such ha he index s nex monh s composiion reflecs he new insrumen balance. When a rebalancing even occurs, i is as if he invesor sells he enire porfolio a he day s closing bid-side prices, and hen immediaely reinvess he proceeds in he new porfolio in proporion o he new marke values based on he same closing bid-side prices. This resuls in a shif in he relaive weighs bu no a change in he overall porfolio value. I is worh noing wha is mean by he amoun ousanding of an insrumen. Recall ha amorizaions and capializaions, where applicable, resul in changes o he amoun ousanding. These changes are passive, however, and are already capured in he effecive selemen price via he balance scalar. Therefore, he figure used in deermining marke value is he original amoun ousanding, plus or minus any acive changes o he amoun ousanding resuling from reopenings or buybacks (which we will refer o as N, he number of bonds ). Since his is an original-face-value concep, i is consisen wih all our oher variables, also defined in erms of original face value. The oal reurn on day, TR, is he arihmeically weighed average of each insrumen s reurn from he period -1 o. The weighs are marke-capializaion weighs from he prior business day, -1: (7) TR i,, 1 i m r L() i,

14 page 14 In his equaion, he ih bond s diry markecapializaion weigh on day -1 is defined by: m i,, 1 where:: and: i L Ni, ESVi,s( 1) Ni, ESVi,s( 1) () i L m () i,, 1 L( ) Insrumen lis on day Las rebalancing day N i, 1 Number of bonds (see above); usually equal o he amoun ousanding, excep for capializing or amorizing bonds Each erm in he summaion in Equaion 7 measures he percenage conribuion of an insrumen o he change in he index porfolio s value beween day -1 and day. Since each insrumen s weigh is updaed daily, i is possible o see how cash reinvesmen is done. Because he effecive selemen price of an insrumen drops concurrenly wih is cash paymen (he accrued ineres, balance scalar, quoed price, or cash-promised variable drops, depending on he ype of insrumen), he insrumen s marke-capializaion weigh drops, raising he relaive imporance of he oher insrumens wihin he porfolio. This achieves cross-index reinvesmen. Since he scheduled cash flow causes he insrumen s marke capializaion and weigh as a percenage of he index o drop, a simulaneous increase in he weigh of he oher insrumens in he index occurs. As a resul of his shif in insrumen weighs, from a mahemaical perspecive cross-index invesmen of he cash flow is achieved. Once he aggregae daily oal reurn of he EMBI Global is known, i is hen applied o he index s prior day closing level o arrive a he curren day s closing value: (8) I I ( + TR ) I The closing cumulaive oal reurn index level for he EMBI Global as of he prior business day (where December 31, ) Price and ineres reurn All of he variables needed o calculae index price reurns are defined above, excep for one. This remaining variable represens he clean marke capializaion, which is compued in an analogous way o he diry marke capializaion, bu uses he cleanprice conceps described earlier for bonds and loans, insead of he effecive selemen price. Therefore, porfolio price reurn is he weighed average in which he weighs are clean of he price reurns of he consiuen insrumens. Ineres reurn calculaions coninue o be based on he same formula. Calculaion of he EMBI Global Consrained The EMBI Global Consrained s daily index value is derived using he same oal reurn calculaion as he EMBI Global. Where he difference arises beween he wo indices is in he underlying bond allocaions. Unlike he EMBI Global, which uses he oal deb sock ousanding per index issue, he EMBI Global Consrained limis he allocaions of index bonds issued by hose counries wih larger deb socks ousanding. Similar o he EMBI Global s radiional markecapializaion weighed reurn, he EMBI Global Consrained s oal reurn on day, (TR FC, ), is he arihmeically weighed average of each insrumen s reurn from he period -1 o. (9) TR FC, FC,i,, 1 i m r L() However, unlike he EMBI Global, he EMBI Global Consrained uses a se of insrumen weighs (m FC ) derived from he marke capializaion of a se of insrumens whose face amoun ousanding allocaions are consrained by a defined algorihm: where: and: m FC,i,, 1 i L i L fc i, N N () m () fc i, ESVi,s( 1) i, ESVi,s( 1) FC, i,, 1 L( ) Insrumen lis on day Las rebalancing day N fc i, Equals N i, x FC i, 1

15 page 15 FC i. The face-consrained facor applied o he curren face amoun ousanding of each counry s eligible deb sock. This facor equals C FC /C sum. and: C sum Ni, B i L() V(), C sum equals he sum of he curren face amouns ousanding for all insrumens belonging o a given EMBI Global counry a ime, while C FC represens he porion of ha counry s curren face amoun ousanding of deb eligible for inclusion in he EMBI Global Consrained. C FC is derived by applying an he following inclusion schedule o he C sum of each counry: 1) 100% of he firs US$5 billion of C sum 2) 75% of C sum ha exceeds US$5 billion bu does no exceed US$10 billion; 3) 50% of C sum ha exceeds US$10 billion bu does no exceed US$15 billion; 4) 25% of C sum ha exceeds US$15 billion bu does no exceed US$25 billion; 5) 10% of C sum ha exceeds US$25 billion bu does no exceed US$35 billion; and 6) 0% of C sum ha exceeds US$35 billion. Once he aggregae daily oal reurn of he EMBI Global Consrained is known, i is hen applied o he index s prior day closing level o arrive a he curren day s closing value: (10) I I ( + TR ) FC, FC, -1 1 FC, where: I FC, -1 The closing cumulaive oal reurn index level for he EMBI Global Consrained as of he prior business day (where December 31, )

16 page 16 J.P. Morgan is or has recenly been an underwrier or placemen agen for securiies of cerain of he above issuers. Addiional informaion is available upon reques. Informaion herein is believed o be reliable, bu J.P. Morgan does no warran is compleeness or accuracy. Opinions and esimaes consiue our judgmen and are subjec o change wihou noice. Pas performance is no indicaive of fuure resuls. This maerial is no inended as an offer or soliciaion for he purchase or sale of any financial insrumen. J.P. Morgan may hold a posiion or ac as marke maker in he financial insrumens of any issuer discussed herein or ac as advisor or lender o such issuer. is a member NASD and SIPC. Copyrigh J.P. Morgan & Co. Incorporaed. Cliens should conac analyss a and execue ransacions hrough a J.P. Morgan eniy in heir home jurisdicion unless governing law permis oherwise.

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