CMTAAdvanced Treasury Workshop

Floating Rate Notes, Fixed to Float Securities, Step Down Bonds and Convexity

Presented by:Tony Garcia, CFAVice President

Pomona, CA

January 31, 2012

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If you can’t explain it to a six year old, you don’t understand

it yourself.

-Albert Einstein

On the Agenda

Floating Rate Securities A security where the coupon floats relative to an index

Fixed to Float Securities A security that has a fixed coupon for a period and then

converts to a floating rate security

Step Down Bonds A callable security where the coupon declines

Negative Convexity The bane of callable buyers

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Floating Rate Securities

Floating Rate Securities

Coupon Floats Relative to Index (Benchmark or Reference rate)

Coupon Rate = reference rate (index) +/- quoted margin

Indexes Fed Funds – Daily Reset Libor – O/N, 1 Month, 3 Month, 6 Month, 12 Month CMT – Spread to Constant Maturity Treasury with regular resets Commercial Paper Prime Rate Treasury Bill – 1 Month, 3 Month, 6 Month TIPS – Inflation Indexed

Inverse Floaters – Where the coupon moves in the opposite direction to the reference rate *You cannot buy these*

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Floating Rate Securities

Issuers Treasury – TIPS Agencies – Debentures and Asset Backed Municipalities Corporations

Discount Margin Effective spread to index

Caps and Floor Cap – The limit to which a coupon can float Floor – Minimum possible coupon Collar – When security has both a cap and a floor

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Components Of Pricing

Spread to Index determines coupon

Reset Frequency

Maturity

Change in Basis

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Discount Margin

Discount margin is the inferred change in spread to Index

Price changes to reflect change in market

Price change = PV of change in DM As with YTM

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Basis Risk

Change in DM to reflect adjustments in market If credit quality improves DM should decline If credit quality deteriorates DM will widen If spreads narrow DM will decline May also change due to change absolute level of interest rates

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ING BANK Step Up FRN

Source: Bloomberg

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ING BANK Step Up FRN

Source: Bloomberg

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ING BANK Step Up FRN

Source: Bloomberg

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Value To A Portfolio

Lower Duration Reset frequency lowers effective duration

Lower Price volatility

Yield will move in direction of underlying index

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Berkshire FRN 2/11/13 Reset 3 MO Libor +43

Source: Bloomberg

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Berkshire FRN 2/11/13 Reset 3 MO Libor +43

Source: Bloomberg

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Berkshire FRN and Treasury 2.75% 2/13

BRK FRN 2/13 TSY 2.75 2/13

DATE PRICE YIELD PRICE YIELD

2/11/10 100.000 DM + 43 104.012 1.40

1/11/11 100.905 DM + 13 106.419 0.62

CHANGE +.905 DM -30 +2.407 -0.78

Note: Settlement date held static at 2/11/10 to avoid amortization effect

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Fixed to float securities

Fixed to Floating Rate Securities

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Securities begin with a Fixed Coupon rate for specified period then will switch to a Floating Rate Coupon

May be bulleted or callable

Issued by Agencies and Corporations

Can provide protection against rising rates Basis shift out of a low volatility environment can be a concern

Agency Fixed to Float

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Source: Bloomberg

Agency Fixed to Float – Coupons

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Source: Bloomberg

Corporate Fixed to Float

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Source: Bloomberg

Agency Fixed to Float – Coupons

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Source: Bloomberg

Step down bonds

Step Down Callable

Security structure where coupon steps down if bond not called

Likelihood of call is very small

Short term cash flow is the focus

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Source: Bloomberg

Step Down Callable

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Step Down Callable – YTC Schedule

Source: Bloomberg

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5 Year Treasury Yield

Source: Bloomberg

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One Time Callable

Source: Bloomberg

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Agency Bullet Yield Curve

Source: Bloomberg

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Step Down Callable OAS Analysis

Source: Bloomberg

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Callable Agency OAS Analysis

Source: Bloomberg

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Step Down Callable – Comparison

YTM Option value

Step Down 2.08 0.59

Callable 2.40 1.82

Treasury 2.07

Agency Bullet 2.25

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Step Down Callable – Cash Flows

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

One time payments Step down payments Bullet Payments

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Convexity

Convexity/Negative Convexity

Convexity A Measure of how curved the price-yield curve is The second derivative of the price-yield function

Low coupon and long maturity bonds tend to have high convexities

High coupon and short maturity bonds tend to have low convexities

Negative Convexity

Where the rate of change of the price of a bond slows as rates fall Generally due to embedded option(s)

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Price / Yield Function

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PRICE

YIELD

Duration

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PRICE

YIELD

Convexity

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PRICE

YIELD

{

}

Convexity Changes

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PRICE

YIELD

Negative Convexity

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PRICE

YIELD

Negative Convexity

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PRICE

YIELD

12 Month Horizon Return

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Pricing Date: 01/16/2013 Type: Spot Curve

Currency: USD Horizon Months: 12

Reinvestment Rate: .104

Issuer Coupon Maturity YTW Eff Dur ConvFieldName -300 -200 -100 0 100 200 300

BULLET 0.750 01/12/2018 0.850 4.886 0.133                

           Total Return 14.254 9.830 5.599 1.555 -2.313 -6.013 -9.553

           Ending Price 112.950 108.547 104.337 100.311 96.461 92.778 89.253

           Ending Avg Life 4.000 4.000 4.000 4.000 4.000 4.000 4.000

           Ending Eff Dur 3.989 3.967 3.946 3.925 3.905 3.884 3.864

           Ending Conv 0.090 0.089 0.088 0.087 0.087 0.086 0.085

STEP UP 0.700 01/30/2018 0.700 2.188 -1.406                

           Total Return 0.350 0.350 0.525 0.547 -1.465 -4.880 -8.463

           Ending Price 100.000 100.000 100.000 100.000 97.861 94.445 90.860

           Ending Avg Life 0.000 0.000 0.000 0.000 3.000 3.500 4.000

           Ending Eff Dur 0.000 0.000 0.000 0.000 2.487 3.401 3.870

           Ending Conv 0.000 0.000 0.000 0.000 -0.307 0.217 0.061

CALLABLE 1.000 01/11/2018 1.000 2.504 -1.647                

           Total Return 0.486 0.486 0.486 0.540 -1.753 -5.442 -8.975

           Ending Price 100.000 100.000 100.000 100.000 97.245 93.554 90.019

           Ending Avg Life 0.000 0.000 0.000 0.000 4.000 4.000 4.000

           Ending Eff Dur 0.000 0.000 0.000 0.000 3.315 3.861 3.842

           Ending Conv 0.000 0.000 0.000 0.000 -0.480 0.083 0.084

FNMA 0.70% 1/30/18 QUARERLY CALLS 7/30/13Coupons: 0.70 to 1/160.875 to 7/161.0 to 1/172.0 to 7/173.0 to 1/18

FHLB 1.0% 1/11/18 QUARTERLY CALLS 7/11/13

FHLMC 0.75% 1/12/18

Source: Bloomberg and Bond Edge

12 Month Horizon Return

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Pricing Date: 01/16/2013 Type: Spot Curve

Currency: USD Horizon Months: 12

Reinvestment Rate: .104

Issuer Coupon Maturity YTW Eff Dur ConvFieldName -300 -200 -100 0 100 200 300

BULLET 0.750 01/12/2018 0.850 4.886 0.133                

           Total Return 14.254 9.830 5.599 1.555 -2.313 -6.013 -9.553

           Ending Price 112.950 108.547 104.337 100.311 96.461 92.778 89.253

           Ending Avg Life 4.000 4.000 4.000 4.000 4.000 4.000 4.000

           Ending Eff Dur 3.989 3.967 3.946 3.925 3.905 3.884 3.864

           Ending Conv 0.090 0.089 0.088 0.087 0.087 0.086 0.085

STEP UP 0.700 01/30/2018 0.700 2.188 -1.406                

           Total Return 0.350 0.350 0.525 0.547 -1.465 -4.880 -8.463

           Ending Price 100.000 100.000 100.000 100.000 97.861 94.445 90.860

           Ending Avg Life 0.000 0.000 0.000 0.000 3.000 3.500 4.000

           Ending Eff Dur 0.000 0.000 0.000 0.000 2.487 3.401 3.870

           Ending Conv 0.000 0.000 0.000 0.000 -0.307 0.217 0.061

CALLABLE 1.000 01/11/2018 1.000 2.504 -1.647                

           Total Return 0.486 0.486 0.486 0.540 -1.753 -5.442 -8.975

           Ending Price 100.000 100.000 100.000 100.000 97.245 93.554 90.019

           Ending Avg Life 0.000 0.000 0.000 0.000 4.000 4.000 4.000

           Ending Eff Dur 0.000 0.000 0.000 0.000 3.315 3.861 3.842

           Ending Conv 0.000 0.000 0.000 0.000 -0.480 0.083 0.084

FNMA 0.70% 1/30/18 QUARERLY CALLS 7/30/13Coupons: 0.70 to 1/160.875 to 7/161.0 to 1/172.0 to 7/173.0 to 1/18

FHLB 1.0% 1/11/18 QUARTERLY CALLS 7/11/13

FHLMC 0.75% 1/12/18

Source: Bloomberg and Bond Edge

12 Month Horizon Return

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Pricing Date: 01/16/2013 Type: Spot Curve

Currency: USD Horizon Months: 12

Reinvestment Rate: .104

Issuer Coupon Maturity YTW Eff Dur ConvFieldName -300 -200 -100 0 100 200 300

BULLET 0.750 01/12/2018 0.850 4.886 0.133                

           Total Return 14.254 9.830 5.599 1.555 -2.313 -6.013 -9.553

           Ending Price 112.950 108.547 104.337 100.311 96.461 92.778 89.253

           Ending Avg Life 4.000 4.000 4.000 4.000 4.000 4.000 4.000

           Ending Eff Dur 3.989 3.967 3.946 3.925 3.905 3.884 3.864

           Ending Conv 0.090 0.089 0.088 0.087 0.087 0.086 0.085

STEP UP 0.700 01/30/2018 0.700 2.188 -1.406                

           Total Return 0.350 0.350 0.525 0.547 -1.465 -4.880 -8.463

           Ending Price 100.000 100.000 100.000 100.000 97.861 94.445 90.860

           Ending Avg Life 0.000 0.000 0.000 0.000 3.000 3.500 4.000

           Ending Eff Dur 0.000 0.000 0.000 0.000 2.487 3.401 3.870

           Ending Conv 0.000 0.000 0.000 0.000 -0.307 0.217 0.061

CALLABLE 1.000 01/11/2018 1.000 2.504 -1.647                

           Total Return 0.486 0.486 0.486 0.540 -1.753 -5.442 -8.975

           Ending Price 100.000 100.000 100.000 100.000 97.245 93.554 90.019

           Ending Avg Life 0.000 0.000 0.000 0.000 4.000 4.000 4.000

           Ending Eff Dur 0.000 0.000 0.000 0.000 3.315 3.861 3.842

           Ending Conv 0.000 0.000 0.000 0.000 -0.480 0.083 0.084

FNMA 0.70% 1/30/18 QUARERLY CALLS 7/30/13Coupons: 0.70 to 1/160.875 to 7/161.0 to 1/172.0 to 7/173.0 to 1/18

FHLB 1.0% 1/11/18 QUARTERLY CALLS 7/11/13

FHLMC 0.75% 1/12/18

Source: Bloomberg and Bond Edge

Portfolio Comparison – Bullets vs Callables

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Security detail

Portfolio Bullets Portfolio CallablesPar $70,000,000 Par $70,000,000

Market Value $71,085,000 Market Value $70,225,000

Average Life 1.328 Average Life 1.246

YTM 0.517 YTM 0.918

Modified Duration 1.31 Modified Duration 3.32

Effective Duration 1.16 Effective Duration 1.30

Convexity 0.10 Convexity -0.77

Porfolio distribution

Source: Bloomberg and Bond Edge

Security Shock Testing

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0.55 0.550.55 0.540.54 0.530.54 0.450.54 0.380.53 0.370.53 0.37

0.08 0.070.08 0.060.06 0.060.06 0.061.13 0.941.67 1.611.67 1.63 $67,998 -3.17%

graphical performace

-0.08%

Aged scenario200 -1.72 0.01 $69,020 -1.72%300 -3.17 0.03

(12 month horizon)

0 0.39 0.00 $70,499 0.39%100 -0.08 -0.14 $70,171

-200 0.30 0.00 $70,432 0.29%-100 0.24 0.00 $70,395 0.24%

-300 0.36 0.00 $70,477 0.36%

$70,994 -0.13%

profile of forward

performance Callables

Yield Change projected total return

ave life effective duration

convexity market value

% change in market value

0.27%

Aged scenario200 0.07 0.00 $71,133 0.07%300 -0.13 0.00

(12 month horizon)

0 0.48 0.06 $71,427 0.48%100 0.27 0.01 $71,276

-200 1.45 0.01 $72,118 1.45%-100 0.92 0.02 $71,737 0.92%

market value

% change in market value

-300 2.00 0.01 $72,508 2.00%profile of forward

performance Bullets

Yield Change projected total return

ave life effective duration

convexity

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

-300 -200 -100 0 100 200 300

Eff DurationBullets Callables

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

-300 -200 -100 0 100 200 300

% volatility of mkt val

Bullets Callables

Source: Bloomberg and Bond Edge

Security Shock Testing

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0.55 0.550.55 0.540.54 0.530.54 0.450.54 0.380.53 0.370.53 0.37

0.08 0.070.08 0.060.06 0.060.06 0.061.13 0.941.67 1.611.67 1.63 $67,998 -3.17%

graphical performace

-0.08%

Aged scenario200 -1.72 0.01 $69,020 -1.72%300 -3.17 0.03

(12 month horizon)

0 0.39 0.00 $70,499 0.39%100 -0.08 -0.14 $70,171

-200 0.30 0.00 $70,432 0.29%-100 0.24 0.00 $70,395 0.24%

-300 0.36 0.00 $70,477 0.36%

$70,994 -0.13%

profile of forward

performance Callables

Yield Change projected total return

ave life effective duration

convexity market value

% change in market value

0.27%

Aged scenario200 0.07 0.00 $71,133 0.07%300 -0.13 0.00

(12 month horizon)

0 0.48 0.06 $71,427 0.48%100 0.27 0.01 $71,276

-200 1.45 0.01 $72,118 1.45%-100 0.92 0.02 $71,737 0.92%

market value

% change in market value

-300 2.00 0.01 $72,508 2.00%profile of forward

performance Bullets

Yield Change projected total return

ave life effective duration

convexity

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

-300 -200 -100 0 100 200 300

Eff DurationBullets Callables

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

-300 -200 -100 0 100 200 300

% volatility of mkt val

Bullets Callables

Source: Bloomberg and Bond Edge

Security Shock Testing

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0.55 0.550.55 0.540.54 0.530.54 0.450.54 0.380.53 0.370.53 0.37

0.08 0.070.08 0.060.06 0.060.06 0.061.13 0.941.67 1.611.67 1.63 $67,998 -3.17%

graphical performace

-0.08%

Aged scenario200 -1.72 0.01 $69,020 -1.72%300 -3.17 0.03

(12 month horizon)

0 0.39 0.00 $70,499 0.39%100 -0.08 -0.14 $70,171

-200 0.30 0.00 $70,432 0.29%-100 0.24 0.00 $70,395 0.24%

-300 0.36 0.00 $70,477 0.36%

$70,994 -0.13%

profile of forward

performance Callables

Yield Change projected total return

ave life effective duration

convexity market value

% change in market value

0.27%

Aged scenario200 0.07 0.00 $71,133 0.07%300 -0.13 0.00

(12 month horizon)

0 0.48 0.06 $71,427 0.48%100 0.27 0.01 $71,276

-200 1.45 0.01 $72,118 1.45%-100 0.92 0.02 $71,737 0.92%

market value

% change in market value

-300 2.00 0.01 $72,508 2.00%profile of forward

performance Bullets

Yield Change projected total return

ave life effective duration

convexity

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

-300 -200 -100 0 100 200 300

Eff DurationBullets Callables

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

-300 -200 -100 0 100 200 300

% volatility of mkt val

Bullets Callables

Source: Bloomberg and Bond Edge

Dynamic Cash Flow Shock Testing

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Bullets Callables Callables Bullets Callables1.05 2.63 1.31 1.29 0.49

$34,985 $34,371 $60,345 $34,959 $60,331

flat fallingBullets

projected duration 1.1612 month reinvestment risk $34,965

rising rates: +100 b.p.

flat rates: 0 b.p.

falling rates: -100 b.p.

analysis of cash flow

rate scenario rising

3498519538 17214

0 0

34371

525215188 8119

8042

$0

$25,000

$50,000

$75,000

$100,000

1 YR 2 YR 3 YR 4 YR 5 YR

Bullets Callables

34965

19468 17160

0 0

60345

7035 3008 0 0

$0

$25,000

$50,000

$75,000

$100,000

1 YR 2 YR 3 YR 4 YR 5 YR

Bullets Callables

34959

19460 17154

0 0

60331

7035 3008 00

$0

$25,000

$50,000

$75,000

$100,000

1 YR 2 YR 3 YR 4 YR 5 YR

Bullets Callables

Source: Bloomberg and Bond Edge

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Contact Information

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Tony Garcia, CFAVice President

MAC A0716-07T400 Capitol Mall, 7th FloorSacramento, CA 95814

Phone: (888) 267-9113 FAX: (916) 442-2750 Email: tgarcia@wellsfargo.com

 The opinions expressed in this presentation are general in nature and not intended to provide specific advice or recommendations. Contact your investment representative, attorney, accountant or tax advisor with regard to your specific situation. The opinions of the author do not necessarily reflect those of Wells Fargo Institutional Securities, LLC or any other Wells Fargo entity.

Wells Fargo Securities is the trade name for the capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, a member of NYSE, FINRA, NFA and SIPC, Wells Fargo Institutional Securities, LLC, a member of FINRA and SIPC, Wells Fargo Prime Services, LLC, a member of FINRA, NFA and SIPC and Wells Fargo Bank, National Association. Wells Fargo Securities, LLC carries and provides clearing services for Wells Fargo Institutional Securities, LLC customer accounts.

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