Gerald A. Beeson

April 14, 2008

Future of Financial Innovation

PRESENTATION TO

Financial Institutions Risk Management Conference

2

Future of Financial Innovation

There is much needed innovation within the derivatives market and many innovations of the past decade have been shut down, perhaps permanently, in risk transfer and funding

Derivative Markets

Continuing problems and hazards with respect to liquidity, transparency, valuation and counterparty credit risk

Securitization Markets

Continued impairment of the securitization market will hinder the transference of risk between providers of credit and pools of available capital

Funding Markets

Beginning to recover after the dislocations of Q3/Q4 and the aftermath

From Vantage Point of Market Participant

3

Derivatives Market

“Risk is essential but it needs to be supported. It’s all about the plumbing.”

Drive toward central clearinghouse (central risk pool) where derivative contracts can be submitted, matched, cleared and settled

Resistance to changes that yield a standardized product that creates a more efficient market

Management of gross notional exposures and mitigation of operational risks

Valuation concerns

Valuation reconciliation between counterparties, particularly during periods of market stress

Counterparty credit concerns

Utilization of collateral posted in the ordinary course of their capital markets activities

• Conversely, counterparties have credit risk that they want to mitigate

Movement to exchange based and cleared products eliminates this asymmetrical benefit

• Relieves potential “run on the bank” concerns seen in 2008

Market Participant Observations

4

0

1

2

3

4

5

6

7

8

9

10

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

Sca

le F

acto

r

OTC Margin Dispute Trends Example

2008 2009

5

Commitment to Innovative Solutions

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Impaired Securitization Markets

7

Shutdown of the Securitization Market

In 2001, Citadel launched a Bermuda based reinsurance business offering large scale, collateralized risk transfers of property and catastrophe risks

Positive performance as business grew (ex 2005); however, needed longer term risk management and capital efficiency strategy in order to grow

Asymmetrical return distributions in best and worst cases

Experience in capital markets led to offering of insurance risk-linked securitization with several benefits

• Active market demand and diversified investor base

• Fully collateralized protection

• Multi-year coverage

• Fixed pricing terms

Placed largest bank debt indemnity deal done to date in July 2007 at $500 M

Market Participant Case Study

8

Alignment of Interest

Citadel and investors’ interests remain aligned throughout the term of the transaction

Citadel must cede all policies within the subject business lines – no potential for adverse selection

At inception Citadel funds retained 100% of the first approximately $650mm of losses each year

Cedants covenant to retain at least 50% of ground up losses below the securitized layer

Losses above the securitized layers are retained by Cedants

Term Loan C

Term Loan A

Cedant Retention

Term Loan D

Term Loan B

Net

Los

ses

$1,200mm/P(E) = 0.2 bps

Limits Written

Cedant Retention

Pro Forma Cedants Exposure

$1,015mm/P(A) = 0.7 bps

$875mm/P(A) = 15.6 bps

$710mm/P(A) = 90.4 bps

$650mm/P(A) = 140.0 bps

9

Risk Exposure

Note: MPCI and property per risk are not included in the above analysis.

Analysis of the pro forma portfolio for calendar year 2007 illustrates per occurrence PMLs

All Peril Occurrence PMLs

$650$710

$875

$1,050

$1,200

Term Loan D AttachmentTerm Loan C Attachment

Term Loan B Attachment

Term Loan A Attachment

Term Loan A Exhaustion

$307

$450

$532$596

$684

$805

20 50 100 250 1,000 25,000

Return Period (yrs) Per Occurrence PML

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Low Probability of Loss ImpactRemodeled Key Historical Events1

$650$710

$875

$1,050

$1,200

Term Loan D AttachmentTerm Loan C Attachment

Term Loan B Attachment

Term Loan A Attachment

Term Loan A Exhaustion

1. 2004 and 2005 hurricanes are modeled using RMS recommended event IDs . Events prior to 2004 are based on stochastically generated storms that are representative of the historical events. Loss figures gross of reinstatement premiums.

2. Katrina does not include marine gulf or flood.

$350

$36 $63 $39 $28 $28 $27

$239

$45 $48

Andrew(1992)

Northridge(1994)

Lothar(1999)

Charley(2004)

Frances(2004)

Jeane(2004)

Ivan(2004)

Katrina(2005)

Rita(2005)

Wilma(2005)

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Projected Earnings Distribution (Combined Gross/Net)

Projected Earnings Distribution as of 1/1/08

(800)

(600)

(400)

(200)

200

400

50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%

Ear

nin

gs (

$m)

Total Gross of Emerson

Total Net of Emerson Percentile Gross Net0.000% 292 271 50.000% 220 199 75.000% 144 123 90.000% (4) (25) 95.000% (143) (164) 98.000% (297) (287) 99.000% (399) (320) 99.600% (502) (355) 99.800% (558) (370) 99.900% (610) (382) 99.998% (851) (459)

Expected 169 150

Key Percentile

-

Cumulative Probability

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Final Analysis

Cost of capital

Capital structure 75% equity and 25% debt

• Debt layer was 3 year term structure at L+100 up for renewal in May 2009

Consideration of increased capital commitment relative to returns generated from other businesses

Securitization Market

Effectively closed to innovative risk management transaction like Emerson Re

Asymmetrical upside/downside relationship would return to the business

Decision to exit the business

Q4 2008 Considerations

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Funding MarketsView from the Eye of the Storm

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Citadel Investment Group

Asset Management Capital Markets

Alternative Asset ManagementMarket Making /

High Frequency TradingCitadel Solutions

• Largest options specialist

• Largest retail equity market maker

• Citadel accounts for approx 30% of US options trading volume and over 8% of US equity volume

• Multi-strategy hedge funds

• Planned single-strategy hedge funds

• Fund administration business offering premium, tailored services to hedge funds

Business Architecture

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Citadel Derivatives Group LLC

8% of US Equity Volume 29% of US Options Volume

Sept 2008 data

A Market Leader in Equities and OptionsEmbracing “disruptive” technologies to improve liquidity and transparency in the capital markets

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End of an EraDisappearance of the “Shadow Banking System”

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Liquidity Reserve

• Maintenance of a pre-funded liquidity reserve to meet contingent cash needs of Citadel’s balance sheet

Counterpart Diversity

• Across both financing and trading counterparts

• Broad distribution of exposures to maintain operational flexibility in a disruptive market environment

• Diverse financing arrangements across highly rated counterparts in robust, efficient structures

Active capital and balance sheet planning

• Targeting the relationship between aggregate risk limits and capital required to support them

• Balance sheet liquidation model: a business unit / strategy analysis of Citadel’s ability to reduce risk positions

Liquidity Management

• Model Citadel’s liquidity ladders to incorporate the following parameters

• Mark-to-Market exposure from stress events

• Expiration of committed funding facilities

• Accelerated Capital Calls

• Reductions in the Balance Sheet of the Firm

Treasury – Liquidity Management PhilosophyEnsure the provision of adequate liquidity to meet balance sheet funding needs through all market environments.

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Crowded Financing Trade

Sources of securities

Sources of cash

Mutual Funds

SecuritiesLenders

Beneficial Owners/Bank Portfolios

Dealer Desks Direct

Customer Supply

Internal Dealer Cash

Securities Lenders Cash Reinvest

US Commercial Banks

Non-US Commercial Banks

Prime Brokers

Hedge FundHedge

FundHedge Fund

Hedge Fund

Hedge Fund

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Treasury – Centralized Execution

Central Funding Approach

Assets are funded centrally through Treasury.

Close collaboration to determine the long term funding needs of the business.

Centralized funding through a diverse network of sources of cash and collateral.

Not reliant on PB model

Direct relationships with sources of cash and collateral

Longer term stable commitments

Started effort over 6 years ago

Sources of securities

Sources of cash

Mutual Funds

SecuritiesLenders

Beneficial Owners/Bank Portfolios

Dealer Desks Direct

Customer Supply

Internal Dealer Cash

Securities Lenders Cash Reinvest

US Commercial Banks

Non-US Commercial Banks

CITADELCITADEL

Prime Brokers

Centralized execution of secured funding provides substantial scalability and efficiency. It also allows PMs to focus on portfolio construction and Treasury specialists to focus on funding.

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Funding Dislocation

Accelerated deleveraging on the back of the financial panic and forced liquidations by banks, hedge funds and other investors in Q3 and Q4

Severe dislocation in funding markets post Lehman bankruptcy driven by several factors

Inadequate funding models among firms taking term asset risk without term liability structure

Concerns around systemic risk in the banking system

Lenders became unwilling or restrictive in lending

• Multiple asset classes impacted, even in fully hedged assets

• Concerns around changing regulatory frameworks Implementation of short sale restrictions by regulators in several markets)

• Ability to liquidate or hedge collateral in a default as primary concern

Breakdown in the relationship between cash and derivative assets, notably in convertible and corporate bonds

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Funding Dislocation

Citadel focus in Q3 and Q4

Holder of balance sheet assets in a period of unprecedented funding dislocation

Key Focus to maintain strong liquidity and capital position through utilization of management framework

• Reduction in size of balance sheet/risk broadly but maintain highest quality trades

• Refocus activities on skill based investment businesses

• Elimination of several balance sheet intensive businesses Reinsurance Fundamental Credit U.S. Power Trading

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Estimated US Non-Financial Convertible Discount to Fair Value

-1.5

-0.5

0.5

1.5

2.5

3.5

4.5

5.5

6.5

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Edg

e (b

pt) .

5.6

The US Non-Financial Convertible Discount to Fair Value time-series represent the average US non-financial convertible bond discount to fair value, weighted by amount outstanding. For this purpose, the Merrill Lynch US Convertible Index is used to define the set of securities considered for inclusion. Convertible securities whose underlyings do not have exchange-traded options, exchangeable bonds, convertible preferred stock, and mandatorily convertible securities are excluded. The Citadel proprietary valuation model is used to estimate fair value. Citadel’s model is calibrated using US Credit, Equity, and Option market data from January 2003 to present. The Estimated US Non-Financial Convertible Discount to Fair Value time-series incorporates a combination of inputs designed to provide reasonable estimates of fair value. Individuals may disagree about the design of the framework as well as the inputs and assumptions made. The framework, inputs and assumptions may not be accurate, and the inputs will change over time. The actual discount to fair value may differ materially from the estimated fair values generated by the Citadel proprietary valuation model. Furthermore, there can be no assurance that market prices will converge to fair value over time.

January 1, 1998 to September 12, 2008

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Estimated US Non-Financial Convertible Discount to Fair Value by Rating

Please see the end notes for important information about this presentation.

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr

Edg

e (b

pt) .

US - All Ratings

US - High Yield

US - Investment Grade

10.5

8.9

5.0

2004 2005 2006 2007 2008 2009

January 1, 2004 to April 6, 2009

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Bond Basis Spreads

0

50

100

150

200

250

300

350

400

450

May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

Spre

ad to

Lib

or .

Representative Bond Basis

Historical Data

2007 2008 2009

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Funding Dislocation – The Road “Forward”

Recent Fed data indicates that total bank deposits were approximately $8.8 trillion versus $3.8 trillion in the money funds with growth rates of 5% and 23%, respectively, during 2008

Over half of money fund growth during Q4 2008

Effect of “breaking the buck”

Growth directed toward S/T Agency and Treasury securities as CP holdings and Repo holdings shrunk

• Repo market down over 30% in Q4 2008; almost 50% in the 2008

• Bank CP market shutdown even with government guarantee programs in place

• Highlights that money funds currently have little use in providing liquidity to the system

Increased importance of bank deposits in traditional mix of short term, medium term and long term secured and unsecured lending by banks for the foreseeable future

Will be constrained by leverage ratio/gross balance sheet concerns

Dysfunctional Funding Market Continues

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End Notes

1. The US Non-Financial Convertible Discount to Fair Value time-series represent the average US non-financial convertible bond discount to fair value, weighted by amount outstanding. For this purpose, the Merrill Lynch US Convertible Index is used to define the set of securities considered for inclusion. Convertibles securities whose underlyings do not have exchange traded options, exchangeable bonds, convertible preferred stock, and mandatorily convertible securities are excluded. The Citadel proprietary valuation model is used to estimate fair value. Citadel’s model is calibrated using US Credit, Equity, and Option market data from January, 2003 to present.