JB Certificates and Warrants on Interest Rates in EUR, USD and CHF

JB Certificates and Warrants on Interest Rates in EUR, USD and CHF Efficient instruments to hedge bonds, mortgages and lombard loans against rising interest rates Zurich, 2013

Content Table Embedded risks when interest rates rise s. 3-4 Hedging interest rate risks with an interest rate swap (IRS) s. 6-7 Solution I: JB Certificates on the 3Y, 5Y and 7Y Interest Rate in EUR and USD s. 9-16 Solution II: JB Interest Rate Call Warrants on EURIBOR and LIBOR s. 18-22 2

Why to hedge a bondportfolio or lombard loan against rising interest rates? Interest rates are still at very low levels and spreads to 3 Months EURIBOR resp. LIBOR are very low EUR Rates (3 Months EURIBOR 0.21%): 3Y 0.47% 5Y 0.89% 7Y 1.18% USD Rates (3 Months LIBOR 0.29%): 3Y 0.56% 5Y 1.07% 7Y 1.47% Market expects that central banks will not increase short term rates in the next 2-3 years, but.. a sudden change in economic data or a change in market behaviour could cause a market shock in interest rates and lift up interest rates fast (= fear that central banks might increase short term rates sooner than expected) Bonds with a duration could sharply fall in price (a bondportfolio with a duration of 7 would fall roughly14% in case of an interest rate increase of 2%) 3

A bond has 3 embedded risks Interest rate risk hedged with interest rate swaps 4.5 Treasury Yield Swap Yield Bond 4 3.5 3 2.5 2 1.5 1 0.5 0 Asset Swap Spread Swap Spread 1. Interest Rate Risk Hedged with Interest Rate Swap = Asset Swap 2. Credit Risk Hedge with Credit Default Swap = CDS 3. Liquidity Risk No Hedge possible! 4

Basics: Hedging interest rate risks with an interest rate swap (IRS) 5

A Swap (Payers) reduces interest rate risk A pays fix interest Swap (engl.) = exchange Derivative contract between 2 parties Exchange of a fix payment versus a floating payment Predefined maturity No exchange of Nominal! Only interest payment Bank A B pays floating interest Bank B Example Bank A pays fix and receives floating payment At trade the pv of the floating is equal to the pv of fix payments If the sum of all received floating payments is higher than the fix payments Bank A makes a profit So Bank A expectes higher rates and Bank B lower rates 6

Summary: Interest Rate Swap Advantages: Client is not exposed to interest rate risks anymore Very liquid hedging instrument Very efficient to change interest rate duration Disadvantages: A plain vanilla swap requires a minimum volume of 2-3 mio. Additional documentation and contracts are needed Cash flows need to be monitored precisely 7

Julius Baer Solution I: JB Certificates on the 3Y, 5Y and 7Y Interest Rate in EUR and USD 8

JB Certificates on 3Y, 5Y or 7Y Interest Rate in EUR and USD Solution Securitization: Certificates are securitized interest rates swaps No stop loss in the product Hedge already possible for EUR 100 resp. USD 100 No documentation needed & listed on SIX - Exchange No additional margins, no margin calls All cashflows are priced into the certificate No need to monitor cashflows 9

Julius Baer Interest Rate Certificates in EUR and USD Product overview Interest Rate Certificates 3Y EUR Interest Rate 5Y EUR Interest Rate 7Y EUR Interest Rate Underlying 3-months EURIBOR 3-months EURIBOR 3-months EURIBOR Maturity Date 11.03.2016 18.06.2018 17.06.2020 Nominal / Ratio EUR 1.00 / 100 EUR 1.00 / 100 EUR 1.00 / 100 Indicative Price* EUR 1.40 EUR 4.44 EUR 8.27 Indicative Interest Rate p.a.* 0.47% p.a. 0.89% p.a. 1.18% p.a. Valor 20230236 20230334 20230335 ISIN CH0202302367 CH0202303340 CH0202303357 Symbol JFPLT JGOZM JKCCT Listing SIX Swiss Exchange SIX Swiss Exchange SIX Swiss Exchange Interest Rate Certificates 3Y USD Interest Rate 5Y USD Interest Rate 7Y USD Interest Rate Underlying 3-months USD LIBOR 3-months USD LIBOR 3-months USD LIBOR Maturity Date 11.03.2016 18.06.2018 17.06.2020 Nominal / Ratio USD 1.00 / 100 USD 1.00 / 100 USD 1.00 / 100 Indicative Price* USD 1.67 USD 5.35 USD 10.30 Indicative Interest Rate p.a.* 0.56% p.a. 1.07% p.a. 1.47% p.a. Valor 20230237 20230336 20230337 ISIN CH0202302375 CH0202303365 CH0202303373 Symbol JFQJZ JKBFH JKSHL Listing SIX Swiss Exchange SIX Swiss Exchange SIX Swiss Exchange * Indicative terms as of 27.03.2013; www.derivatives.juliusbaer.com/rates 10

Hedging a EUR Bondportfolio Example with 3Y EUR Certificate Valor 202230236 / CH0202302367 / JFPLT Bondportfolio Yield 1.20% p.a. Client Pays fix 0.47% p.a. (or 1.40% for 3 years) Floating 3 Months Euribor JB Certificate Bondportfolio: 1 Mio. EUR Mod. Duration: 3.00 years Average Yield 1.20% p.a. 3 Years Swap EUR 0.47% p.a. Price Certificate in EUR: 1.40 (3 x 0.47%) Asset swap: 0.73% p.a. 0.73% p.a. = Average Yield 1.20% p.a. Swap 0.47% p.a. Summary: Client exchanged his 3 years fixed Bondportfolio into a 3 years floating rate portfolio which pays now: 3 Months Euribor + 0.73% p.a. (= Asset Swap) After Hedge: Interest Rate Duration: Credit Duration: 0.25 years 3 years 11

How many certificates do I need to buy to hedge my bondportfolio? Formula: (Market Value Bondportfolio or Loan * Hedging period) (Nominal Certificate* Ratio * Years to maturity of Certificate) Example how to hedge: Bondportfolio: EUR 1 000 000 Duration: 3.0 / Yield 1.20% Remaing years certificate: 3 years Nominal Zertifikat: EUR 1.00 Ratio: 100 Number of Certificates (1 000 000 * 3.00) = 10 000 Certificates (1 * 100 * 3) Cost and Leverage: Price 1 Certificate : 1.40 Cost of Hedge: 10 0000 * 1.40 = EUR 14 000 Cost of Hedge in Percentage of Bondportfolio EUR 14 000 / EUR 1 000 000 = 1.40% (=Equal to a leverage of 71.43X) 12

Hedge Bondportfolio - Scenario Analysis Immediate Interest Rate Change Bondportfolio Value Certificate P&L Hedge Combined in EUR -1.00% +3.00%/ EUR +30 000 0.00 EUR -14 000 +16 000* -0.50% +1.50%/ EUR +15 000 0.35 EUR -10 500 +3 500* +/- 0.00% 0.00% 1.4 EUR 0.0000 0 +0.50% -1.50%/ EUR 15 000 2.90 EUR +15 000 0 +1.00% -3.00% / EUR -30 000 4.40 EUR +30 000 0 At maturity after 3 Years: 3M Euribor average fixing rate Bondportfolio Value Certificate at Maturity P&L Hedge Combined in EUR/annualized return for 3 Years -1.00% EUR 36 000 (Yield 1.20% p.a.) 0 EUR -14 000 +22 000/+0.73%** -0.50% EUR 36 000 (Yield 1.20% p.a.) 0 EUR -14 000 +22 000/+0.73%** +/- 0.00% EUR 36 000 (Yield 1.20% p.a.) 0 EUR -14 000 +22 000/+0.73%** +0.40% EUR 36 000 (Yield 1.20% p.a.) 1.2 EUR + /- 0.00 +36 000/+1.13%** +1.00% EUR 36 000 (Yield 1.20% p.a.) 3 EUR +16 000 +52 000/+1.73%** +2.00% EUR 36 000 (Yield 1.20% p.a.) 6 EUR +46 000 +82 000/+2.73%** * The product can not fall below the value of 0 in case of negative rates (positive convexity) ** Equal to an average 3M Euribor Rate + Asset Swap of 0.73% p.a. 13

Hedging a USD Lombard loan: Example with 5Y USD Certificate 20230336 / CH0202303365 / JKBFH 3M USD LIBOR + 0.75% margin Example: Client has 3.5 Mio USD Lombard Loan He pays 3M LIBOR plus margin of 0.75% p.a. Client was to hedge interest rate risk for 5 years Lombard Loan Lombard Loan Floating: 3M USD LIBOR + 0.75% p.a. margin Client Pays fix 1.07% p.a. (or 5.35 for 5 years) Floating : 3M USD LIBOR Client JB Certificate Hedge: Buy 3.5 Mio / 100 = 35 000 Certificates Price: 35 000 * USD 5.35 = USD 187 250 Indicative Interest Rate: 5.35 / 5 = 1.07% p.a. Summary after hedge: Client cannot benefit anymore from lower rates BUT now he knows his interest payments for the next 5 years No interest rate risk anymore, no more leverage risk Client has a fixed term loan with for 5 years and pays 1.07% p.a. + 0.75% p.a. = 1.82% p.a. 14

Listing on the SIX Swiss Exchange Independent Hedge Investors s Bank Foating LIBOR or EURIBOR LIBOR or EURIBOR based Loan Investor Fixed Rate Long Leverage Certificate Investor (internal or external) is independent of his bank, he can hedge his interest rate exposure via a listed product Investor can do a hedge with a securitized swap he normally could only do if nominal is higher than 2 Mio Full flexibility, always fair value and real time pricing on SIX At what interest rate do I enter into the hedge? Loss if rates are rising Profit if rates are sinking Profit if rates are rising Loss if are sinking Example*: Price 8.27, Maturity 7 = 1.18% (8.27/7) Price 4.44 Maturity 5 = 0.89% (4.44/5) Price 1.67 Maturity 3 = 0.56% (1.67/3) * Only for Ilustration without accrual effect 15

Summary - JB Certificates on the 3Y, 5Y and 7Y Interest Rate in EUR and USD Advantages: Very simple product to hedge interest rate exposure No documention needed Listed on SIX Swiss Exchange, very liquid secondary market Certificates pay the sum of all 3M Euribor in EUR certificate or 3M Libor in USD certificate fixing If rates are rising investor is fully hedged, if rates are sinking close to 0 or below benefit of positive convexity Disadvantage: Client / Investor gives up potential that interest rates (resp. Euribor or Libor Rates) will stay low 16

Julius Baer Solution II: JB Interest Rate Call Warrants on EURIBOR resp. LIBOR 17

Julius Baer Interest Rate Warrants in CHF, EUR and USD Product overview Interest Rate Warrants 10Y CHF Call 10Y EUR Call 10Y USD Call Underlying 3-months CHF LIBOR 3-months EURIBOR 3-months USD LIBOR Maturity Date 31.03.2023 31.03.2023 31.03.2023 Nominal Amount CHF 100.00 EUR 100.00 USD 100.00 Ratio 1:1 1:1 1:1 Strike 1.50% 2.00% 2.50% Indicative Price* CHF 5.64 EUR 5.65 USD 7.33 Valor 21020545 21020546 21020547 ISIN CH0210205453 CH0210205461 CH0210205479 Symbol SFCPX EUCPY USCPZ Listing SIX Swiss Exchange SIX Swiss Exchange SIX Swiss Exchange * Indicative terms as of 27.03.2013; www.derivatives.juliusbaer.com/rates 18

10 Years CHF Libor Cap Warrants Strike 1.50% Valor 21020545 / SFCPX Libor Cap Warrants are call warrants on the 3 Month CHF LIBOR, therefore a premium is paid upfront If the 3 Month CHF LIBOR fixes above the strike of 1.50% p.a. on the observation date, the investor gets paid the difference between the Libor and the strike. If the Libor fixes below the strike of 1.50% p.a. there is no amount paid For this right the investor pays a premium for the warrant upfront for the whole hedging period. This is reflected in the price of the warrant 19

Example: Hedging a 3 Month LIBOR Mortgage with a Cap Warrant Initial situation client: CHF 1 000 000 3 Month CHF LIBOR mortgage, client credit margin 1% Wants to benefit if rates stay low or even fall further Wants to have a «cap» on interest payments at 1.50% (without credit margin) Market Data (example): 10 year swap rate: 1.20% 10 year fixed mortgage 2.20% (= 10 Years Swap rate + 1% credit margin) Cap Underlying: CHF 3 Month LIBOR Strike: 1.50% Price: CHF 5.90 (0.59% p.a.) = costs CHF 59 000 Breakeven: 1.50% (=Strike) + 0.59% (Premium p.a.) = 2.09% (= above this average rate for 10 years for the 3 months CHF LIBOR the premium is offset) 20

Example: Hedge LIBOR Mortgage with a Cap Warrant Strike 1.50% 6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50 6.00 Libor Mortgage Value Cap Mortgage + Cap Fixed Mortgage 21

Summary - JB Interest Rate Call Warrants on EURIBOR and LIBOR Advantage: A cap warrant is a proper instrument to hedge interest rate exposure The investor is able to cap his interest rate exposure for a certain period The client profits from low interest rates with his LIBOR mortgage or Lombard Loan, in case of increasing LIBOR rates he is hedged above the strike Transparent and a fairly priced product which listed on the SIX Exchange The client can hedge his interest rate risk independent from his loan Risks: A premium has to be paid, like an issurance premium The possibility exists that the option expires worthless The valuation of the warrant is mark to market, the investor needs to be aware of the effect on day to day P&L swings 22

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