EFTA01393113.pdf

on long-term bonds or money market instruments, will generally cause prices of outstanding debt securities to increase. Conversely, rising rates across a particu- lar maturity spectrum will generally cause the prices of outstanding debt securities of that maturity to decline. EXAMPLE: A 30-year Treasury bond pays inter- est at a 12% coupon rate. The only time prior to matur- ity that investors will pay a price of 100 (that is, 100% of par value) for the bond is when the prevailing yield on such long-term Treasury bonds is exactly 12%. Should rates move higher to, say, 14% for such Treasury bonds, the price of an outstanding 12% bond would have to decline to about 86 in order for the bond to yield 14%. If rates on such bonds subsequently de- cline to 10%, the price of the 12% bond could be ex- pected to rise substantially above par, since it would yield 10% at a price of 120. Price-based call options become more valuable as the prices of the underlying debt securities increase, and price-based puts become more valuable as the prices of the underlying debt securities decline. The relationship between interest rate changes, prices, and the value of price-based debt options can be ex- pressed as follows: Prices t Call I Interest Rates (Yields) 4 - Put & Interest Rates (Yields) t = Prices 4 _ Call Put t In contrast, the exercise settlement value of a yield- based option is based on the difference between the value of an underlying yield and the exercise price of the option. Since the underlying yields of yield-based options will increase as interest rates increase, and vice-versa, it follows that yield-based calls become more valuable as yields rise (Le., as the prices of the debt securities from which the underlying yield is de- rived decline), and puts become more valuable as yields decline (and prices of such securities increase). These relationships can be expressed as follows: _ Call Interest Rates (Yields) ; = Prices t Put t - Interest Rates (Yields) t = Prices I _ Cali t - Put i 30 CONFIDENTIAL - PURSUANT TOEFEESERL%0066515 P. 6(e) CONFIDENTIAL SDNY_GM_00244699 EFTA01393113