Credit Derivatives Product ManagementJ.P. Morgan Securities Inc.New York2Q02Andrew Palmer (212) 834-7083

Credit Derivatives Product Management www.morgancredit.com

Please visit our website for live 2-way creditdefault swap quotes:http://www.morgancredit.com

Distribution of this report is restricted in certain countries. Important information concerning these and other restrictions is set forth at the end of thisreport.

PRODUCT REPORT

Credit Derivatives: A Primer

Highlights• A Credit Derivative is a bilateral financial contract that isolates the credit risk of a

reference credit and transfers that risk between two parties.• JPMorgan estimates that the credit derivative market grew to $2 trillion by year-end

2001, more than doubling in size over year-end 2000 and increasing tenfold over thelast four years.

• Credit Default Swaps represent 95% of all credit derivatives.

• Credit derivatives do not create a new form of risk but provide a new way to transferexisting credit risk.

• Credit Derivatives act as a conduit for information across markets for distinct assetclasses.

• Credit derivatives provide a liquid market for short sales of credit instrumentswithout the risk of a short squeeze.

• The credit derivative market provides liquidity when clients need it the most.

• A Credit Default Swap (the most common credit derivative) is a bilateral financialcontract by which the protection Buyer pays a periodic fee in return for a contingentpayment by the protection Seller, if a credit event occurs with respect to the designatedReference Entity.

• A Credit Linked Note is a security with principal and/or coupon payments linked to theoccurrence of a credit event with respect to a specific reference entity.

• Like most derivatives, credit derivatives have evolved a variety of structural variations,which can be executed in either an unfunded or a funded form.

• Investors extract Relative Value through a two-step decision process:1. Do I like the credit?2. How do I obtain the best value for taking credit risk?

• To determine relative value, we must isolate the credit portion of the cash instrumentand compare it to the credit derivative spread.

• Credit Default Swaps add depth to the secondary market for credit risk beyondthe secondary market for the underlying credit instruments.

• Credit derivatives free investors from maturity and availability constraints of the cashmarket.

Contents

The Case for Credit Derivatives

................................................... 2

Basic Credit Derivative

Structures ................................ 7

Common Pricing Factors ........ 9

ISDA and Credit Derivative

Contracts ............................... 10

Conclusion .............................11

IFR Credit Derivatives House of the Year

Risk Credit Derivatives House of the Year

Best Online Derivatives Research and Analysis

This article introduces the basic structures for and applications of credit derivatives thathave emerged in recent years. The applications discussed provide strategies for riskmanagers addressing portfolio concentration risk, for issuers seeking to minimize the costsof liquidity in the debt capital markets, and for investors pursuing assets that offerattractive relative value. Credit derivatives create enormous opportunities to profit fromdiscrepancies in the pricing of credit risk across distinct markets through the ability tobypass barriers between different asset classes, maturities, rating categories, andcurrencies.

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 2

What are credit derivatives?

A Credit Derivative is a bilateral financial contract that isolates the credit risk of a reference credit andtransfers that risk from one party to another. In doing so, credit derivatives separate the ownership andmanagement of credit risk from other qualitative and quantitative aspects of ownership of financialassets. Thus, credit derivatives share a key feature of other successful derivative products, which is thepotential to achieve efficiency gains through a process of market completion. Credit derivatives canachieve market completion by allowing credit risk to be transferred to the most efficient holder of thatrisk, even if the underlying asset could not be transferred to that holder.

Until the advent of an efficient credit derivative market, credit remained a major component of businessrisk for which no tailored risk-management products existed. To manage credit risk, loan portfoliomanagers were limited to a strategy of portfolio diversification backed by line limits, with an occasionalsale of positions in the secondary market. Derivative users were limited to purchasing insurance, lettersof credit, guarantees, or negotiating collateral provisions to Master Agreements. Corporations eithercarried open exposures to key customers’ accounts receivable or purchased insurance, where available.Investors were constrained in their activities by the availability of publicly traded assets inpredetermined maturities and volumes. These strategies are inefficient because they do not separatecredit risk from the asset associated with that risk.

Consider a corporate bond which represents a bundle of risks including duration, convexity, callability,and credit risk (constituting both the risk of default and the risk of volatility in credit spreads). If theonly way to adjust credit risk is to buy or sell that bond, which would consequently affect positioningacross the entire bundle of risks, there is a clear inefficiency. Fixed income derivatives introduced theability to manage duration, convexity, and callability independently of bond positions. Creditderivatives complete the process by providing the ability to independentlymanage default and creditspread risk.

When comparing investing in Credit Default Swaps versus investing in bonds, the protection Seller isanalogous to the buyer of bonds, because both are accumulating credit risk. Accordingly, the protectionBuyer is analogous to the seller of bonds because both are shorting credit risk.

The importance of credit derivatives

Until recently, the credit derivative market was perceived as a tool used by banks to achieve regulatorycapital relief. Banks have expanded their use of credit derivatives to include economic risk reduction aswell. Furthermore, since 1997, the credit derivative market has seen dramatic increases in usage byother active participants (re-insurance and insurance companies, asset managers, mutual funds, hedgefunds, corporations, and CDOs) creating substantial growth and liquidity in the marketplace. Let’sexplore two applications used by recent entrants to the credit derivative market to extract value:

Application: Credit Default Swaps create liquidityCredit Default Swaps add depth to the secondary market for credit risk beyond that of the secondarymarket of the underlying credit instruments which, may not be liquid for a variety of reasons. Loansales or the assignment or unwinding of other derivative contracts typically require the notificationand/or consent of the customer. Credit derivatives allow users to reduce credit exposure in aconfidential transaction, where the reference entity need neither be party to the transaction nor evenaware of it. The transaction occurs without physically transferring the assets.

THE CASEFOR CREDIT

DERIVATIVES

THE CASE

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 3

A structured tax or accounting position can create significant disincentives to sell an otherwise liquidposition. Credit derivatives can hedge the credit exposure without triggering a sale for either tax oraccounting purposes.

In many cases, Credit Default Swaps can create exposure comparable to the underlying creditinstrument or likewise can hedge exposure contained in an asset that an individual cannot or does notwant to sell. For example, companies often face business concentration risk to key customers throughaccounts receivable. An insurance contract may provide compensation for provable losses. However,Credit Default Swaps do not require an actual loss to be incurred and they can be traded in thesecondary market, providing an effective hedge for credit deterioration as well as default.

Application: Exploiting a funding advantage or avoiding a disadvantageThe return for assuming credit risk of an asset is the net spread earned after deducting the investor’scost of funding the asset. For example, it makes little sense for an A-rated bank funding at LIBOR flatto lend money to a AAA-rated entity that borrows at LIBID: After funding costs, the A-rated bank takesa loss but still owns the risk.

In the cash market, entities with a high cost of funds buy higher risk assets to generate spread income.However, since there is no funding requirement for most credit derivatives, investors can take exposureto more highly rated, but uncorrelated credits and realize a profit at a lower overall risk. On the otherhand, institutions with low funding costs may capitalize on their funding advantage by purchasingcredit-risky assets while buying protection on the same credit risk. As long as the premium for buyingprotection is less than the net spread earned on an asset containing the credit risk (referred to asnegative basis), the investor retains a net positive income stream, but remains credit neutral with respectto the Reference Entity.

The exponential growth of the credit derivative market has been a watershed development in credit riskmanagement for both investors and hedgers across a broad spectrum of market participants and assetclasses. Credit derivatives are fundamentally changing the way risk managers price, hedge, transact,originate, distribute, and account for credit risk. While the above definition of credit derivativescaptures traditional credit instruments (guarantees, letters of credit, and loan participations), newercredit derivative structures provide greater precision in isolating, managing, and transferring genericcredit risk.

Increased use of Credit Derivatives

JPMorgan estimates that the global credit derivative market grew to $2 trillion by year-end 2001,more than doubling in size over year-end 2000 and increasing tenfold over the last four years. Thegraph below illustrates the increase in use of credit derivatives over time by different sectors of thecredit derivative market, which in turn has driven growth in the overall credit derivative market.

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 4

Chart 1: Market Growth

Several distinct arguments combine to account for the increased use of credit derivatives by allinstitutions that routinely carry credit risk as part of their day-to-day business.

1. The credit derivative market provides liquidity to the cash market in times of market stress.Since the advent of the credit derivative market, and particularly throughout 2001, we have seen thatduring times of overall market stress the credit derivative market has been the first source of liquidity.

A good case study of how the credit derivative market reacts during times of general market stress canbe seen by examining trading flows before and after the week of September 11. Based on the averageof the four trading weeks preceding September 11, the weekly trading volume of credit derivativesalmost tripled when financial markets resumed full activity on September 17. During this time periodthe credit derivative desk intermediated consistent two-way flows (see chart 2 below). The percentageof protection bought as compared to protection sold did not change to a large degree.

The credit derivative market is better able to provide liquidity during periods of market stress than thecash market because of the way the respective trading desks are traditionally positioned. Cash desksare typically long risk because they hold an inventory of bonds. Credit derivative desks are typicallyshort risk because they hold an inventory of credit protection. During periods of market stress, clientscan reduce long risk positions by either selling bonds or buying protection. At such times, cash desksare reluctant to increase their inventory and assume more risk by purchasing bonds from clients. Incontrast, credit derivative desks are happy to go from short to flat by selling their inventory ofprotection (the equivalent of going long a cash bond). Credit derivative desks can also sourceadditional protection from clients who had previously used the product to short credits and now wish tomonetize that position. These characteristics support two-way flows in the credit derivative market andprovide liquidity and accurate credit pricing when other markets are less active.

Total Growth

Banks Re-insurers Hedge Funds Real Money

1994 20021998

Evolution of the Credit Derivative Market

Real Money

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 5

Chart 2: Market Stress

2. The credit derivative market also provides liquidity to individual credits under stress.The same factors which allow credit derivatives to add liquidity to a stressed market also allow it toprovide liquidity to individual names – an inventory of protection held by dealers and a desire amongother clients to monetize naked short positions.

An excellent example of how the credit derivative market provides liquidity to deteriorating credits isthe decline of Enron. As disclosure of Enron’s off balance sheet liabilities caused spreads to widen,Credit Default Swaps in Enron became more active and continued to trade in standard size (USD5,000,000 to 10,000,000) across the curve. Eventually, S&P downgraded Enron’s debt to junk, whichcaused Dynegy to pull out of a planned merger. When the downgrade occurred, liquidity in Enronbonds was limited to those maturing in August 2009 trading in lots which rarely reached USD5,000,000. At the same time, dealer desks continued to sell their inventory of protection and helpedclients monetize protection they had previously purchased. In fact, trading continued right up untilEnron filed for bankruptcy protection in early December 2001.

In addition to demonstrating how the credit derivative market adds liquidity, the Enron bankruptcy alsoshows how effective credit derivatives function as a product. Enron was the largest and most liquidentity in the credit derivative market to have a Credit Event. Once the bankruptcy occurred, CreditDefault Swaps were triggered and settled in an orderly and timely fashion without dispute – the productworked as expected.

Protection bought40%

Protection sold60%

Protection sold44%

Protection bought56%

Prior four-week average September 17–21

100% 56%

270%

Prior 4-weekavg.

Sept. 10–14 Sept. 17–21

Total notional of credit derivativevolume

Source: JPMorgan internal data

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 6

3. Credit Derivatives act as a conduit for information across markets for distinct asset classes.

Chart 3: Central Location

In sourcing and selling generic credit risk, the credit derivative desk serves as a link between manydifferent markets. As a result of its central position the credit derivative market will often account forprice movements in the cash market. If a corporation is obtaining a new loan, institutions exposed tothe credit risk of that loan will often seek a hedge against concentrations of risk by using creditderivatives. As lenders purchase protection on an entity to which they are exposed, spreads in the creditderivative market will widen. This change will occur before the effects of the new loan have rippledthrough to be reflected in bond market spreads. Thus, the credit derivative market will serve as a linkbetween institutionally separate markets.

4. Credit derivatives isolate credit from other aspects of ownership of credit instruments.The Reference Entity, whose credit risk is being transferred, need neither be a party to a creditderivative transaction, nor even aware of it. This confidentiality enables risk managers to isolate andtransfer credit risks discreetly, without interfering with important business relationships. In contrast, aloan assignment through the secondary loan market requires borrower notification, and a silentparticipation requires the participating bank to assume as much credit risk to the selling bank as to theborrower itself.

Since the Reference Entity has no seat at the negotiating table , the terms (tenor, seniority,compensation structure) of the credit derivative transaction can be customized to meet the needs of thebuyer and seller of risk, rather than the particular liquidity or term needs of a borrower. The availabilityand discipline of accurate market pricing enable institutions to make pricing and relationship decisionsmore objectively.

5. Credit derivatives are the most efficient way to short a credit without the risk of a shortsqueeze. While it is nearly impossible to achieve long term repo funding for corporate bonds or short-sell a bank loan, a short position can be synthetically achieved by purchasing credit protection.Consequently, risk managers can short specific credits or a broad index of credits, either as a hedge ofexisting exposures or simply to profit from a negative credit view. The possibility of short sales thenopens up a wealth of arbitrage opportunities. Global credit markets display discrepancies in the pricingof the credit risk across different asset classes, maturities, rating categories, and currencies. Thesediscrepancies persist because arbitrageurs have traditionally been unable to purchase cheap obligationsagainst shorting expensive ones to extract profit. As these opportunities are exploited, credit-pricingdiscrepancies will gradually disappear.

JPMorgan CDSTrading Desk

Equity market Convertiblemarket

Cred. Der.Ctpy. Risk

Bond market

Loan market

CorporateReceivables

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 7

6. Credit derivatives (except when embedded in structured notes) are off-balance-sheetinstruments offering considerable flexibility in terms of leverage. The appeal of off- as opposed toon-balance-sheet exposure increases with increasing funding and asset administration costs.. Bankloans have not traditionally appealed to hedge funds and other non-bank institutional investors becauseof the administrative burden of assigning and servicing loans and the absence of a repo market.Without the ability to source secured financing for bank loans via a repo market, the return on capitaloffered by bank loans has been unattractive to institutions that do not enjoy access to unsecuredfinancing. However, by taking bank loan exposure using a credit derivative, a hedge fund can bothsynthetically finance the position and avoid the administrative costs of direct asset ownership. Thedegree of leverage will depend on the amount of up-front collateralization, if any, required by the swapcounterparty. Credit derivatives have opened up new ways to distribute the credit risk embedded inbank loans and other instruments into the institutional capital markets.

Credit Default Swaps A Credit Default Swap (the most common credit derivative) is a bilateral financial contract by which theprotection Buyer pays a periodic fee in return for a contingent payment by the protection Seller, if a creditevent occurs with respect to the designated Reference Entity.

Chart 4: Credit Default Swap

Credit Linked Notes

A Credit Linked Note is a security with principal and/or coupon payments linked to the occurrence ofa credit event with respect to a specific reference entity. In effect, a Credit Linked Note embeds aCredit Default Swap into a funded asset to create a synthetic investment that replicates the credit riskassociated with a bond or loan of the reference entity. Credit Linked Notes are typically issued on anunsecured basis directly by a financial institution, but may also be issued from a collateralized specialpurpose vehicle (typically a trust). Credit Linked Notes provide access to the credit derivative marketfor investors who cannot trade derivatives or do not have an ISDA Master Agreement with JPMorgan.

Credit Linked Notes may be issued directly by JPMorgan Chase Bank or through a special purposevehicle (SPV) program. CORSAIR is the brand name for JPMorgan's proprietary SPV program forissuing Credit Linked Notes. In the U.S. each CORSAIR credit linked note is issued by a discretebankruptcy remote trust established solely for the purpose of that specific transaction. Other CORSAIRvehicles exist in various jurisdictions throughout the world to address investor needs as well as tax andstructural considerations. Each CORSAIR vehicle has standardized documentation and minimalexecution costs, creating a platform for efficient and timely CLN issuance.

RiskReferenceentity

Protection buyer

Fee/premium

Protection sellerContingent payment on default

BASICCREDIT

DERIVATIVE

STRUCTURES

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 8

Chart 5: Corsair Credit-linked note Trust program

Other Credit Derivatives

Like most derivatives, credit derivatives have already evolved a variety of structural variations whichcan be executed in an unfunded or funded form. Examples include:• “First to Default Basket”: A credit derivative, which transfers credit risk with respect to multiple

reference entities. The protection Seller agrees to make a contingent payment to the Buyer withrespect to the first reference entity in the basket for which a credit event occurs, and does not haveexposure to subsequent credit events.

• “First-Loss Basket”: A credit derivative in which the Seller of protection agrees to makecontingent payments to the Buyer of protection upon the occurrence of a credit event with respectto one or more reference entities. The contingent payment amount for each credit event equals parless the liquidation value of an obligation of the impaired reference entity, with the aggregateamount of contingent payments due by the Seller of protection capped at an agreed portion of thetotal reference portfolio. The structure allows the Seller of protection to obtain levered exposure toa portfolio of credits.

• HYDI-100 (High Yield Debt Index) is designed to provide investors with the ability to trade on aliquid diversified index that is highly correlated with the JPMorgan Domestic High-Yield Index.The HYDI-100 consists of a basket of 100 Credit Default Swaps referencing a diversified pool ofhigh-yield credits. The pool of credits within the contract remains static for the five-year life ofthe trade, but a new five-year contract referencing an updated pool of names is offered every sixmonths. The index offers investors exposure to a hundred different credits in over twenty sectorsin the high yield market.

• “Synthetic Securitization”- A first-loss basket structure that references a portfolio of bonds, loansor other financial instruments held on a firm’s balance sheet. The technique replicates the creditrisk transfer benefits of a traditional cash securitization while retaining the hedged assets on thebalance sheet of the bank. Advantages over cash securitization include reduced cost, ease ofexecution and retention of on-balance sheet funding advantage.• BISTRO (Broad Index Secured Trust Offering), the synthetic securitization program

developed by JPMorgan, is a structure that transfers tranches of credit exposure to largediversified portfolios of commercial or consumer loans from the securitizing bank toinvestors.

(1) L+10

L+90

(2) 80bps

Certificates

AAA Asset-Backs Trust JPMC

(3) Trust setup cost

Credit defaultswap

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 9

Relative Value analysis of Credit Swaps

Determining the Relative Value of a credit derivative is important when an investor must decidewhether to use derivatives or cash instruments to go long or short credit risk. From many investors’perspectives, credit derivatives add value simply by providing access to credit exposure from sourcesthat would not otherwise be available (i.e. market completion). However, where credit derivatives existin parallel with alternative investments offering similar risks, the investor needs to ascertain the relativevalue of a credit derivative position in comparison to more traditional assets (like bonds or loans). Inorder to make this comparison we need to price the credit risk embedded in the cash instrument. For thetraditional fixed-income investor, it is possible to envision a bond containing three types of risk:• Credit Risk• Funding Risk• Interest Rate Risk

Since a Credit Default Swap isolates credit risk, its theoretical price should be the price of a bondstripped of interest rate and funding risk. Typically, bonds are offered as fixed-rate investments whoseprices are expressed as a spread over treasuries. These bonds can be asset-swapped into a floating rateinvestment with a return expressed as a spread over LIBOR. When purchasing a bond, an investor hasto borrow to fund the asset, therefore the cost of funds must be subtracted from the return on the asset tofind the net return. Since Credit Default Swaps are unfunded investments, the LIBOR portion of thisequation can be removed leaving the theoretical price of the credit risk. This calculation assumes thatthe investor funds at LIBOR flat. If credit protection is offered in the marketplace at a level higher thanthe theoretical price of credit risk, then more relative value is achieved through selling protection overbuying the bond.

Chart 6: Comparing Bonds with Credit Default Swaps

Int. Rate Risk

Funding

Credit

Bond/loan

Credit

T + Y bps

Asset swap

Credit

Funding

Libor + X* bps X* bps

CDS

*Where X = (T+Y) minus Swap Rate

Consider a five year corporate bond trading at a spread of 120bps over Treasuries. Assuming an assetswap spread of 80bps, the bond can be swapped to pay a floating rate of LIBOR plus 40bps. Aninvestor with a cost of funds of Libor flat will have a return of 40bps. Also assume credit protection isoffered at 50bps per annum. Since the Credit Default Swap pays the investor a spread that is 10bpswider than the asset swapped spread, it can be argued that selling protection (long risk) offers bettervalue (positive basis) relative to purchasing an asset swapped bond. Of course, if an investor has ahigher cost of funding than LIBOR flat, the economics of selling protection versus buying the bondbecome even more compelling.

Positive basis can exist for many reasons. A protection buyer may be willing to pay a higher price forcredit protection than the LIBOR stripped, asset swapped equivalent of a bond, because its risk islocated in a different market (loan, convertible, or receivables) where the cost of holding the samecredit risk is more expensive. Since credit derivatives allow the isolation and transfer of credit risk

COMMONPRICING

FACTORS

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 10

across asset classes, credit risk should naturally move to the most efficient (i.e. cheapest) holder of thatrisk.

Counterparty considerations

In a Credit Default Swap, the protection Buyer has credit exposure to the protection Seller contingenton the performance of the Reference Entity. If both the Reference Entity defaults and the Seller defaultsthen the Buyer is left exposed, although the final recovery rate on the position will benefit from anypositive recovery rate on obligations of both the Reference Entity and the Seller. Counterparty riskconsequently affects the pricing of credit derivative transactions. Protection bought from higher-rated-counterparties will command a higher premium. Similarly, protection purchased from a counterpartywhose default probability is highly correlated with that of the Reference Entity will lead to a lowerpremium. When trading with JPMorgan, counterparty credit risk for lower rated counterparties ismitigated through the posting of collateral, rather than through the adjustment of the price forprotection. Therefore, counterparties who have executed with a CSA (Collateral Support Annex) withJPMorgan will receive substantially better execution.

International Swaps and Derivatives Association

Increased standardization in credit derivative documentation has been an important factor in themarket’s growth and liquidity The International Swap and Derivatives Association (ISDA) hasproduced a standardized short form letter confirmation for Credit Default Swaps which incorporates the1999 ISDA Credit Derivatives Definitions and various supplements thereto, and which is transactedunder the umbrella of its ISDA Master Agreement. Standardized confirmation and market conventionsmean the parties need only specify the terms of the transaction (see below), which inherently differfrom trade to trade.

Credit Derivative Contracts

When entering into a Credit Default Swap, several key aspects of the contract need to be agreedbetween the parties:• Reference Entity• Credit Events (usually standard market convention)• Settlement Method (usually standard market convention)• The party who is the Buyer and the party who is the Seller• Scheduled Termination Date (the date on which protection ends)• Notional of the Trade (Fixed Rate Payer Calculation Amount)• Price (Fixed Rate) – expressed in basis points per annum

Defining the Reference Entity is perhaps the most important aspect of the credit derivative contractbecause it ensures that the counterparties are hedging or taking exposure to the proper risk. If theoperating subsidiary of a holding company files for bankruptcy, but the holding company does not, onlythe swaps which reference the bankrupt company will trigger.

A Credit Event is the occurrence of a significant event that triggers the contingent payment on a CreditDefault Swap. The Credit Events are defined in the 1999 ISDA credit derivatives definitions. Theyinclude the following events:• Bankruptcy

ISDAAND

CREDITDERIVATIVECONTRACTS

New York J.P. Morgan Credit Derivatives: A PrimerAndrew Palmer (212) 834-7083 Page 11

• Failure to Pay• Restructuring

The Settlement Method for a standard Credit Default Swap is Physical Settlement. Upon occurrenceof a Credit Event, the protection Buyer will physically deliver obligations from a predefined set ofDeliverable Obligations in return for a payment of par. Following physical delivery, the protectionSeller is in the same position as if they had purchased the cash instrument prior to default. This meansa protection Seller will face a similar loss experience after a Credit Event regardless of whether theypurchased bonds or sold protection.

Credit Default Swap Maturities usually run up to ten years, with five years being the most liquidmaturity.

The average Notional of the typical trade is about $5 to $25 million for investment grade referenceentities, $2 to $5 million for high yield credits and $5 to $20 million for emerging market credits.However, substantially larger transactions can be and have been executed with relative ease. CreditDefault Swaps, and indeed all credit derivatives, are almost exclusively inter-professional (meaningnon-retail) transactions. While publicly rated credits enjoy greater liquidity, ratings are not necessarily arequirement. The only true limitation to the parameters of a Credit Default Swap is the willingness ofthe counterparties to act on a credit view.

The use of credit derivatives has grown exponentially since the beginning of the decade. Transactionvolumes have picked up from the occasional tens of millions of dollars to regular weekly volumesmeasured in hundreds of millions of dollars. While it is true that banks have been the foremost users ofcredit derivatives to date, it would be wrong to suggest that banks will be the only institutions to benefitfrom them. The end-user base is broadening rapidly to include a wide range of broker-dealers,institutional investors, money managers, hedge funds, insurers, reinsurers, and corporates. Growth inparticipation and market volume is likely to continue at its current rapid pace, based on the unequivocalcontribution credit derivatives are making to efficient risk management, rational credit pricing, andultimately, systemic liquidity. By enhancing liquidity, credit derivatives achieve the financialequivalent of a “free lunch” whereby both Buyers and Sellers of risk benefit from the associatedefficiency gains. Credit derivatives can offer both the Buyer and Seller of risk considerable advantagesover traditional alternatives. Both as an asset class and a risk management tool, credit derivativesrepresent an important innovation for global financial markets with the potential to revolutionize theway that credit risk is originated, distributed, measured, and managed.

CONCLUSION

Additional information is available upon request. Information herein is believed to be reliable but JPMorgan does not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject tochange without notice. Past performance is not indicative of future results. The investments and strategies discussed here may not be suitable for all investors; if you have any doubts you should consult your investment advisor.The investments discussed may fluctuate in price or value. Changes in rates of exchange may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale ofany financial instrument. JPMorgan and/or its affiliates and employees may hold a position or act as market maker in the financial instruments of any issuer discussed herein or act as underwriter, placement agent, advisor orlender to such issuer. J.P. Morgan Chase & Co. and/or its subsidiaries and affiliates has likely managed or co-managed an offering of securities within the past three years for the credits mentioned within this presentation.Copyright 2002 J.P. Morgan Chase & Co. All rights reserved. JPMorgan is the marketing name for J.P. Morgan Chase & Co., and its subsidiaries and affiliates worldwide. J.P. Morgan Securities Inc.,is a member of the NYSEand SIPC. J.P. Morgan Chase H&Q is a division of JPMSI. J.P. Morgan Chase & Co., is a member of FDIC. J.P. Morgan Securities Asia Pte Ltd., (JPMSA) and Chase Manhattan Asia Ltd., are regulated by the Hong KongSecurities & Futures Commission. JPMSA is regulated by the Monetary Authority of Singapore and the Financial Services Agency in Japan. J.P. Morgan Futures Inc., is a member of the NFA . Issued and approved fordistribution in the UK and the European Economic Area by J.P. Morgan Securities Ltd., and Chase Manhattan International Limited, members of the London Stock Exchange and regulated by the Securities and FuturesAuthority. Issued and distributed in Australia by Chase Securities Australia Limited and J.P. Morgan Australia Securities Limited which accept responsibility for its contents and are regulated by the Australian Securities andInvestments Commission. J.P. Morgan Australia Pty Ltd. is a licensed investment adviser and futures broker member of the Sydney Futures Exchange. Clients should contact analysts at and execute transactions through aJPMorgan entity in their home jurisdiction unless governing law permits otherwise.