EFTA01393163.pdf

2. The sources of price information used to price credit default options are subject to a lack of transparency and. at times. illiquid markets. This is attributable to, among other things: (1) the absence of last sale information and the limited availability of quotations for the reference oblige- tion(s). (2) lack of ready availability of information on related products traded primarily in the over-the-counter market, and (3) the fact that related over-Me-counter market credit derivative transactions are privately negotiated and may not be made public in a timely fashion or at all. 3. Dealers in the underlying debt securities and in the over-the-counter credit derivatives markets have access to private quotation networks that give actual current bids and offers of other dealers. This information is not available to most investors. As a result, these dealers may have an advantage over participants with regard to credit default options. 4. If the listing options market determines that a credit default option is subject to a redemption event (i.e.. the issuer or guarantor pays off the reference obligation), the option will expire worthless unless a credit event has been confirmed to have occurred prior to the effective date of the redemption event. As a result, purchasers of such options will lose their premium since there is no chance of occur- rence of a credit event for the reference entity. On the other hand. if a redemption event occurs but a credit event Is confirmed to have occurred prior to the effective dale of the redemption event. a seller would be obligated to pay the cash settlement amount even though a holder of the refer- ence obligation may not incur a loss. 5. Since succession events are determined by the listing options market, credit default options may be modi- fied to specify a different reference entity or several different reference entities. As a result, there may be new reference obligations that have higher or lower credit quality than the original reference obligation. In addition, other factors may exist that could affect the likelihood of the occurrence of a credit event. As a result, the occurrence of a succession event could affect the price of these options. Moreover, since the listing options market determines whether a succession event occurred and the adjustment resulting from such an event, the adjustment made to these options may be at variance with the treatment given to the same succession event with respect to related credit derivative products. 6. The occurrence of a credit event must be con- f►med by the listing options market. This means that there will be a lag time between the actual occurrence of a credit event and the listing options market's confirmation of the credit event. Rules of the options market may provide a specified time period (e.g.. four business days) between the end of the covere d and the expiration date for a series of credit default options to allow the options market to con- firm whether a credit event occurred during the covered period. There is a risk, however, that the sources used to monitor a credit event may not identify and report a credit event in a timely fashion. For example, it is possible that a credit event could occur on the last day of trading, but the sources which report the occurrence of a credit event do not 120 CONFIDENTIAL - PURSUANT TOCRESDRI1OR398605 P. 6(e) CONFIDENTIAL SDNY_GM_00244789 EFTA01393163