GLOBAL MARKETS UPDATE

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1 April 29, 2005 GLOBAL MARKETS UPDATE Global Business Opportunities in Financial Market Risk Management Union Bank of California Global Markets Published by UBOC Global Markets. This report has been prepared from sources we believe to be reliable. We make no claim as to its accuracy. Any opinions expressed are not that of UBOC and/or its affiliates. UBOC may act as principal or as agent in a security mentioned. All prices and rates are subject to change without notice. 10 yr T-note Yield History (since 1/03) Jul Oct Jan Apr DJIA (since 1/1/03) Yield_ Consider using FX strategies beyond forward contracts: optionalities offer protection against your exposure while preserving the right for upside potential. (p. 2) You like a Cap but don t like the expensive premium? Consider a Knockout Cap if you feel LIBOR cannot rise perpetually. (p. 3) Fed is expected to raise another 25bp on May 3. Investors may want to put money in shorter maturities: auction rate securities seem to offer ample yield pick-up. (p. 4) UBOC Global Markets Group - Serving Your Needs Let us help your customers with their global financial management needs. Jul Oct Jan Apr Foreign Exchange - Jim Griffin ( ) Interest Rate Derivatives Jeff Hiraishi ( ) Securities Trading & Sales Jeff Katz ( ) Editor - Tomoko Iwakawa ( ) Contact Carolyn Allen for distribution requests for Global Markets Update on

2 FOREIGN EXCHANGE: A Dynamic Approach to FX Hedging While it is easy to think of the FX hedging decision as simply a matter of deciding whether to fix exchange rates today via FX forwards or to remain unhedged in hopes of favorable future spot rates, this decision does not always have to involve a tradeoff between the certainty of fixed rates and uncertainty of future spot rates. Particularly, the flexibility of FX options combines the best of both worlds, providing protection from unfavorable exchange rates while enabling upside benefit. By utilizing a more comprehensive approach to managing FX risk via FX options, the hedger can transform the question of whether to hedge to what strategy is most suitable given the client s risk/return profile. This approach is illustrated in the following example: Assumptions- Company XYZ is an importer with the following euro payable: Amount: EUR 1,000,000 Due Date: 3-months EUR Spot Rate: $1.3000/euro Risks- XYZ is exposed to rising EUR/$ exchange rate, which will increase import costs. Rising EUR/$ are directly correlated with import costs, i.e., a 10% rise in the euro translates to an equal rise in import costs and vice versa. This risk also corresponds to XYZ s unhedged risk profile. Hedging Alternatives- FX Forward Contract: XYZ buys EUR forward. Spot: Fwd. Pts: All-In Rate: : $1,303,500 Advantage: Fixes exchange rate today for future conversion. Disadvantage: No upside benefit from favorable exchange rates at maturity. Upside Benefit: None Upfront Cost: None Range Forward: XYZ buys EUR call & sells EUR put. Call Strike (max. rate): $ Put Strike (min. rate): $ Max. : $1,333, Min. : $1,278, Range Forward Con t.: Advantage: Sets maximum and minimum exchange rate allowing for benefit from a fall in the euro. Disadvantage: Maximum protection rate less favorable than FX forward rate. Upside benefit limited by min. rate floor. Upside Benefit: Yes; to min. rate put strike Upfront cost: None Forward Extra: XYZ buys EUR call & sells EUR put with knockin trigger. Forward Extra Rate (max rate): $ Trigger: $ Max. : $1,313, Min. : $1,242, Advantage: Sets maximum exchange rate while enabling benefit from a fall in the euro. Protection rate better than Range Forward with wider range of benefit from a falling euro. Disadvantage: Forward Extra becomes forward contract if trigger is touched at anytime during option life. - -Upside Benefit: None -Upfront Cost: None Participating Forward: XYZ buys EUR call for EUR 1MM and sells EUR put for EUR 0.5MM (50% of call). Participating Fwd. Strike (max rate): $ Max : $1,320, Min Amt: $0.5MM(1.32) + $0.5MM(spot) Advantage: Sets maximum exchange rate while obligating XYZ to buy only half amount if spot rates at maturity fall. No limit to upside benefit. Disadvantage: Max rate less favorable than forward rate. Upside Benefit: None Upfront Cost: None Conclusion: The FX hedging products above free XYZ from having to choose between the certainty of fixing rates today vs. remaining unhedged in hopes of better spot rates at maturity. Through the preceding FX option products, XYZ gains protection from rising euro rates while preserving benefit from a drop in the euro. The decision then becomes what product Range Forward, Forward Extra or Participating Forward is most suitable for the client s objectives. David Rhee

3 DERIVATIVES: Knock-Out Caps Market Update: The swap market has been volatile with the positive and negative economic releases as of late, trading in a 10-15bp range. The spreads between the 2-year swap and 10-year swap continue to narrow, currently at 55bp. Implied volatility continues its slow grind upwards due to increased Fed uncertainty after the May FOMC meeting. Periodic Knock-Out Cap Counterparty s who are looking for other Cap alternatives to reduce their outright premium, may want to consider doing a Knock-out Cap. Structure A Periodic Knock-out cap is a strategy that can hedge a counterparty s interest rate exposure at a below-market premium. The structure enables the counterparty to buy down the cap premium by allowing the cap to knock-out or cancel for the periods when LIBOR sets at or above a predetermined trigger rate. If rates stay below the trigger rate throughout the life of the cap, the counterparty benefits from paying a below-market premium on the cap. Example Trade Date: April 27, 2005 Effective Date: April 30, 2005 Maturity Date: April 30, 2008 Notional Amount: 10,000,000 Cap Buyer: Counterparty Cap Seller: Union Bank of California, N.A. Floating Rate: 3Month LIBOR Payment Dates: Last day of each April, July, October, and January, subject to the Modified Following Business Day Convention. Day count Basis: Actual/360 Cap Strike: 4.00% Trigger Strike: 6.00% Knock-out Provision: If the Floating Rate (LIBOR) for a calculation period is less than the Trigger Rate, the 4.00% strike will be the effective cap rate. If the Floating Rate for a calculation period is greater than or equal to the Trigger Rate, the cap rate cancels and there will be no exchange of interest with the customer. Premium: (Premium for 4.00% Cap Outright): Rationale 114bp 143bp The counterparty has an existing 3-year floating rate liability. In order to buy cap protection from rising rates, the counterparty faces paying a prevailing cap premium of 143bp. Instead, the counterparty can choose to pay a below market rate of 114bp (29bp savings) in exchange for selling UBOC an option to cancel the cap rate for periods when 3-month LIBOR sets at or above 6.00%. With the 3-month LIBOR currently at 3.18%, LIBOR rates would have to increase by 282 basis points in order for the knockout option to take effect. The risk associated with this strategy is that LIBOR may meet or exceed the trigger rate of 6.00% in the future, forcing the counterparty not to be hedged for that period. Jeffrey Hiraishi

4 [ Pr of essional] 1/ 6/ / 12/ 2005 ( NYC) SECURITIES INVESTMENT: Rates Continue To Rise What a difference a month makes! At the time of last month s commentary, my esteemed colleague wrote of the twoyear Treasury Note yielding 3.90% (see chart below), and the tenyear Treasury Note yielding 4.64% (see chart on page 1). Today, investors look longingly back to March, when it seemed we saw the world through rose-colored glasses: Robust growth was the prediction, and inflation was the price we might pay for a rapidly heating economy. Where did it all go wrong? The Fed at its meeting in March was optimistic about economic growth by predicting the current expansion to accelerate over the next two years. The consensus was that the Fed would continue to raise rates at a measured pace, keeping an eye on inflation, which had picked up, rather than the potential for slower growth. Some Fed-watchers were beginning to look for a 50 basis point rise at the next FOMC meeting on May 3rd. Today s economy looks a little different from March s. Beginning on March 28 th, bonds have done little but rally. Currently, the two-year Treasury Note is yielding 3.64%, 26 basis points lower than last month s commentary. The ten-year Treasury Note is yielding 4.26%, almost half a percentage point lower than last month. Economic data, continued rising oil prices, a record trade deficit, and a jittery stock market have all conspired to push yields back to levels that many thought we had left in the rearview mirror. Consumer confidence fell again, retail sales fell, business sales fell, and leading indicators fell. Inflation numbers were higher, pointing to the s-word: stagflation. Oil prices although off their highs, continue to rest in the mid to high $50s. The trade deficit rose to over $60 million, so one should not have been surprised to see the stock market struggling to reach 11,000, and suddenly act like the Lakers, and spend the last 6 weeks dropping to it s current level of 10,150. What then is in store for the economy and specifically the bond market in the months ahead? 4 We believe the Fed will continue to raise the overnight fed funds target to at least 3.50% by the end of the year, with the next rate hike coming May 3rd. The economy will continue to expand, albeit at rates closer to 3% than 4%. Yields on two year Treasuries will rise again above 4%, while slowly dragging longer maturities yields higher as well. Investors should continue to remain defensive, concentrating purchases with short maturities. Auction Rate Securities continue to offer ample pickup in yield to comparable product. For those with longer maturity needs, callable agencies continue to offer some further yield, but purchases if possible should be restrained until higher yields ensue. Let me end with a quote from Fed Governor Kohn: A time will come when we cannot provide guidance about our policy intentions because we ourselves will not be confident about the strategy that will be needed. 2 yr T-note yield history (since 1/1/04) Yield_ Craig G. Burrell

5 [ Pr of essional] [ Pr o f e s s io n a l] 1/ 5/ / 12/ 2005 ( NYC) 1/ 6/ / 11/ 2005 ( NYC) [ Pr of essional] [ Pr o f e s s io n a l] 1/ 5/ / 12/ 2005 ( NYC) 1/ 6/ / 11/ 2005 ( NYC) 244 ADDITIONAL INDICATORS EUR/$ History (since 1/1/04) $/ History (since 1/1/04) / Crude Oil History (since 1/1/04) Bbl 50 Natural Gas History (since 1/1/04) BTU This report is published by the UBOC Global Markets Group to provide general information to its customers and prospects. This report does not attempt to address the specific needs or objectives of any recipient. And it is not an offer to buy or sell any security or other investment product. Investment products mentioned in this report (i) may involve considerable risk, (ii) are not deposits, or obligations of, or guaranteed by UBOC or its affiliates, and (iii) are not insured by the FDIC or any government agency. Recipients should consult appropriate advisers and use independent judgment before taking any action. Derivatives and foreign exchange products (except FX spot transactions) are available only for eligible swap participants as defined in 17 CFR Part 35. This report has been prepared from sources believed to be reliable but it is not guaranteed to be accurate. Any opinions expressed are not those of UBOC or its affiliates. All prices, rates and other information are subject to change without notice. UBOC and other persons may make use of or act on the information contained in this report prior to its distribution. UBOC may act as a principal or agent with respect to any security or other investment product mentioned in this report. 5