gy o - gy 5 1. introduction general principles of pricingdirect’s evaluation methodology...

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www.pricing-direct.com 1

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Disclaimer

©JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC. All services are

subject to applicable laws and regulations and service terms. Not all products and services are available in

all geographic areas. Eligibility for particular products and services is subject to final determination by J.P.

Morgan and/or its affiliates/subsidiaries.

PricingDirect Inc. does not provide any accounting, regulatory or legal advice. Although the information

contained herein has been obtained from sources believed to be reliable, its accuracy and completeness

cannot be guaranteed. Pricing Direct is a wholly-owned subsidiary of J.P. Morgan Chase & Co. Pricing

Direct is neither a broker-dealer nor a member of any Exchanges or self-regulatory organizations. Pricing

Direct does not hold securities or trade; and, pricing services provided by PD are not intended to be, nor

should they be considered an offer to purchase or sell securities or as a representation that a purchase or

sale could be accomplished at such price. Research services referenced are products of J.P. Morgan

Securities, LLC (“JPMS, LLC”, Member SIPC, Finra, the NYSE and most major exchanges) and or JPMCB.

Securities products and trading services are offered through JPMS, LLC in the United States.

© 2017 PricingDirect Inc. All rights reserved. PricingDirect®, TransparencyDirect® and PricingStudio® are

registered trademarks of JPMorgan Chase & Co. J.P. Morgan Securities LLC is a registered broker-dealer

and a member of the NYSE, FINRA, and SIPC. v. 20170405

v.20170405

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Table of contents

1. Introduction ...............................................................................................5 General Principles of PricingDirect’s Evaluation Methodology .................5

2. Definitions ..................................................................................................8 Pricing Factors .........................................................................................8

3. Government and Supranational Securities .............................................9 U.S. Treasury Securities...........................................................................9 U.S. Government Agency Debentures and Supranationals.................... 10 U.S. Government Agency and Supranational STRIPs ........................... 11 European Sovereigns and Supranationals ............................................. 12

4. Mortgage-Backed Securities .................................................................. 13 To Be Announced Securities (TBAs) ...................................................... 13 Stipulated To Be Announced Securities (Stip TBAs) .............................. 15 Options on To Be Announced Securities (TBA Options) ........................ 16 Fixed-Rate Pass-Through Certificates (Specified Pools)........................ 17 Adjustable-Rate Mortgage Securities (ARMs) ........................................ 19 Small Business Administration Pools (SBAs) ......................................... 20 Structured Agency Mortgage IO/PO ....................................................... 21 Agency Mortgage Inverse IO .................................................................. 22 Collateralized Mortgage Obligations (CMOs) ......................................... 23 Commercial Mortgage Backed Securities (CMBS) ................................. 35 Delegated Underwriting and Servicing Pools (DUS) .............................. 36 GNMA Project Loan Securities ............................................................... 37 Hard-to-Value Securities (HTV) .............................................................. 38 European Mortgage-Backed Securities (MBS) ....................................... 40 Australian Mortgage-Backed Securities (MBS) ...................................... 42

5. Asset-Backed Securities ........................................................................ 44 Autos ...................................................................................................... 44 Credit Cards ........................................................................................... 45 Manufactured Housing ........................................................................... 46 Student Loans ........................................................................................ 48 UK and European Auto Loans, Student Loans, Consumer Loans and

Credit Cards ........................................................................................... 49

6. Collateralized Loan and Debt Obligations ............................................ 50 Broadly Syndicated and Middle Market Structures (CLOs) .................... 50 Small and Medium Enterprise Structures (SME CLOs) .......................... 50

7. Corporate Securities ............................................................................... 52 Investment Grade Corporate Bonds ....................................................... 52 High Yield Corporate Bonds ................................................................... 53 European Investment Grade and High Yield Corporate Bonds .............. 55 European Covered Bonds ...................................................................... 55 Emerging Market Bonds ......................................................................... 56

8. Money Market Instruments ..................................................................... 57 Corporate and Asset-Backed CP, Repurchase Agreements (RPs),

Certificates of Deposit (CDs), and Bankers’ Acceptances (BAs) ............ 57

9. Interest Rate Derivatives ........................................................................ 59 Interest Rate Swaps, Inflation Swaps, Cross Currency Swaps and

Forward Rate Agreements ..................................................................... 59 Interest Rate Swaptions, Caps, Floors and Collars ................................ 59 Forward Starting Interest Rate Swaptions .............................................. 62 Inflation Caps, Floors and Collars .......................................................... 62

PricingDirect, Inc.

Unmesh Bhide, CFA Managing Director

+1 212 272 8703

[email protected]

Sales

George Maloney Executive Director +1 212 272 8896 [email protected]

Danielle Agrapides Executive Director +1 212 272 0879 [email protected]

Ira Barry Executive Director +1 312 732 5712 [email protected]

Michael Cebo Executive Director +44 20 7742 7708 [email protected]

Brett Johnson Analyst +1 212 2729765 [email protected]

Christopher Kim Vice President +1 212 272 4731 christopher.kim @jpmorgan.com

Lance Kisling Executive Director +1 212 272 7792 [email protected]

Michael O’Mealey Executive Director +1 617 310 0756 [email protected]

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mailto:[email protected]

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Hybrid Structures .................................................................................... 64

10. Credit Derivatives .................................................................................... 66 Credit Default Swaps (Single Name CDS) ............................................. 66 Credit Default Swap Indices (CDSI) ....................................................... 68 Credit Default Swap Index Tranches (CDSI Tranches) .......................... 70 Credit Default Swap Index Options (CDSI Options) ............................... 72

Bond Forwards………………………………………………………………..71

Bond Total Return Swaps…………………………………………………...71

11. Mortgage Synthetic ................................................................................. 74 IOS/POS/MBX Total Return Swaps ....................................................... 74

12. Foreign Exchange Derivatives ............................................................... 75 Forwards, Non-Deliverable Forwards, Average Rate Forwards, ............ 75 Double Average Rate Forwards, Average Strike Forwards, ................... 75 Vanilla Options, Asian Options, Digital Options, Barrier Options, ........... 75 Basket Options, Basket Average Options, Touch Options, .................... 75 Average Strike Options, Double Average Options, Swaps, .................... 75 Variance Swaps, Volatility Swaps .......................................................... 75

13. Equity Derivatives ................................................................................... 77 Vanilla Options, Asian Options, Barrier Options, .................................... 77 Variance Swaps, Callable Total Return Swaps ...................................... 77

14. Commodity Derivatives .......................................................................... 78 Vanilla Options, Asian Options, Basket Options, .................................... 78 Basket Average Options, Forwards, Swaps, Basis Swaps, .................... 78 Spread Swaps, Callable Total Return Swaps ......................................... 78

15. ASC Topic 820 ......................................................................................... 80

16. Summary: PricingDirect Product Coverage .......................................... 83

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1. Introduction

General Principles of PricingDirect’s Evaluation Methodology

PricingDirect evaluates over 1.3 million assets every business day. In order to develop market-

based evaluations for this universe of domestic and international taxable fixed income securities

and other assets, PricingDirect has established a valuation process that is supported by

professional evaluators. Throughout each day, the evaluators track the market by interacting

with various market participants, and capture market intelligence for traded, quoted securities. In

addition, they also analyze the market to understand how less liquid securities move compared

with actively traded securities.

Since only a small fraction of all fixed income securities may be traded on a given day, it is an

enormous challenge to evaluate the large number of securities that are not traded. PricingDirect

has developed a methodology that relies on information from J.P. Morgan trading desks and

research, other market participants including our clients, electronic trading platforms such as

TRACE, and/or third-party data vendors to provide market intelligence. In order to create a

reliable, systematic and scalable process, PricingDirect has classified the instruments it

evaluates into over 40 broad asset classes, and over 500 more detailed sub-sectors. Within

each of these asset classes, we have developed methodologies that allow us to utilize available

market information to evaluate the full universe of securities. Though the details of the

evaluation methodology may be different for each asset class, PricingDirect’s generic evaluation

methodology includes the following steps:

Trader Input: For all asset classes, PricingDirect receives information about traded

securities and evaluations of benchmark securities directly from the J.P. Morgan trading

desks. For most asset classes, PricingDirect also receives information from other market

participants including our clients, electronic trading platforms such as TRACE, and/or third-

party data vendors. The J.P. Morgan trading desks are direct market participants who trade

in their asset class every business day and commit capital to support markets. PricingDirect

treats their evaluations as the market level, and does not describe how the traders determine

their evaluations since they are the market makers. The traders may use models while

trading.

Traders provide PricingDirect with evaluations for actively traded securities, i.e., those

securities that are very liquid such as government securities, TBA mortgages, certain agency

CMOs, and benchmark securities in other asset classes, including securities whose issuers

are in the news. All such evaluations of actively traded securities contain information and

intelligence that can be used to evaluate less actively traded securities. The information that

PricingDirect receives from other sources may be used to supplement the information

obtained from the J.P. Morgan trading desks, or to perform quality control procedures on that

information, or for a combination of both.

Quality Control on Trader Input: The trader input is treated as sample input from market

participants. PricingDirect evaluators may perform quality control tests on prices obtained

from the trading desk and/or other sources, using established principles and procedures.

Some sample evaluations are not used in the methodology development, but are used

instead for out-of-sample testing. As a result of these quality control procedures, evaluators

may adjust the prices that PricingDirect receives from its sources for certain securities.

Calculated Input: J.P. Morgan research has developed state-of-the-art analytical models

and statistical techniques, which may be used to determine the underlying evaluation factors

(e.g., spreads, credit curves, forward curves, prepayment speeds). For example,

PricingDirect evaluators may use mortgage prepayment and default models to determine

projected prepayment speeds and default rates for mortgage-backed securities.

Rules Based Adjustments: The securities in each asset class are grouped by security

characteristics and/or performance. PricingDirect evaluators, in conjunction with the trading

desk, develop rules based logic to evaluate such groups of securities. Starting with the bonds

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evaluated by traders, they may adjust the pricing factors so that they can evaluate other

securities in the same asset class. This methodology uses market observable input from both

traders and evaluators based on historical data and current market conditions. These inputs

may reflect relative differences among evaluation factors or adjustments for specific

characteristics of securities within an asset class.

Evaluation Models: PricingDirect evaluates the remaining securities in each asset class

using the previously established evaluation factors and the NPV or OAS models developed by

J.P. Morgan research.

Out-of-Sample Testing: PricingDirect tests out-of-sample evaluations to ensure that the

evaluation methodology is optimal for all securities. This process is repetitive and dynamic,

and requires frequent analysis by PricingDirect’s evaluators to ensure that we deliver market-

based valuations.

Refinements: Current offerings, actual transactions and prior evaluations are monitored in

order to continually refine the evaluation methodology. As securities change over time, our

evaluation methodology may be adjusted to be consistent with current conditions. For

example, corporate bond evaluations reflect the impact of any ratings downgrades, while

evaluations of CMOs reflect the current cashflow profile of each tranche, so a “busted PAC”

would be evaluated as a sequential bond.

Quality Control on Output: Prior to each delivery, PricingDirect evaluators perform multiple

quality control procedures on final output, including tests for “stale” prices and validation of

day-to-day price changes. For derivative instruments, additional controls are performed on

volatility inputs, swap curves, currency exchange rates and other factors, including model

output such as DV01.

Mean Pricing: PricingDirect provides bid, mean and offer evaluations for fixed income

securities. For each fixed income asset class, PricingDirect has developed mean pricing

methodologies that account for the unique trading characteristics of that asset class.

Depending on the asset class, the methodology may incorporate dollar duration, spread

duration, average life, dollar price spread, or a combination of these and other factors. With

regards to our derivatives pricing, we provide a mid-market evaluation, which is market

convention.

Price Challenge Process

PricingDirect has developed a comprehensive price challenge process. Using a web portal or an

Excel add-in, clients can register price challenges and receive real-time challenge responses.

Challenges are re-evaluated against trading desk information, external sources, news, and

market intelligence, and the original evaluation is confirmed or adjusted. PricingDirect’s

proximity to J.P. Morgan’s global trading desks means evaluators have quick access to

comprehensive market color.

PricingDirect aims for a 24 hour response time for challenges from mutual fund clients, and a 48

hour response time for all other clients. We also accommodate some mutual funds’ need to

receive a response before 6:00 PM ET on the day of the evaluation.

Multiple Delivery Options

PricingDirect’s global mutual fund and UCITS clients may be subject to regulations about

reporting NAV, which require them to take market snapshots at specific times during the day.

PricingDirect can provide its clients with evaluated prices for market snapshots that are used by

market participants in the Americas, Europe, the Middle East and Asia. Please see the Product

Delivery Matrix on the following page for details.

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2. Definitions

Pricing Factors

Description

Within this document, the following definitions apply to the terms used in the “Pricing Factors” section. Average Life: The average number of years that each dollar of principal remains outstanding; the weighted average time to the receipt of all future cashflows, where the weights are the dollar amount of the cashflows. BEEM (Bond Equivalent Effective Margin): Discount margin discounted at semi-annual frequency. CDR (Conditional Default Rate): The annualized rate of involuntary principal prepayments (i.e. defaults) of a mortgage backed security. CPR (Constant Prepayment Rate): The annualized rate of principal prepayments of a mortgage backed security. The prepayments measured by this rate can be voluntary, involuntary (i.e. defaults), or a combination of both. CPJ: A prepayment assumption used for GNMA project loans that combines both a voluntary CPR rate (i.e. “15 CPJ”), and an involuntary default rate that is derived from an industry standard default curve assumption for this asset type. Because of the addition of the GNMA project loan default curve to the base CPR assumption, the composite prepayment speed implied by “15 CPJ” will be higher than 15 CPR. CPY (Constant Prepayment Yield): A prepayment assumption used for commercial mortgage-backed securities (CMBS), whereby the security is assumed to pay at zero CPR through the yield maintenance period, and then the designated constant CPR thereafter. DM (Discount Margin): The return that is expected to be earned in addition to the index underlying a floating rate fixed income security. OAS (Option Adjusted Spread): The single spread that, when added to all projected future rate paths, discounts the cashflows of a fixed income security to its price. Payup: The additional price, relative to a generic benchmark, that is demanded for a mortgage backed security that has one or more specific characteristics. Severity: The percentage loss on a loan balance. A 65% severity equates to a 35% recovery. Spread/Nominal Spread: The additional return over a benchmark that is expected to be earned by an investor in a fixed income security. Volatility: As used in the generation of projected future rate paths, a measure of the standard deviation from the mean for a set of observations. Yield: The discount rate that equates the present value of a bond’s cashflows to its price. Z-Spread (Zero Volatility Spread): The spread that, when added to the zero volatility forward rate path, discounts the cashflows of a fixed income security to its price.

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3. Government and Supranational Securities

U.S. Treasury Securities

Description

These securities include the following instruments that are issued by the U.S. Treasury, and

backed by the full faith and credit of the U.S. government:

U.S. Treasury Bills, Notes and Bonds

U.S. Treasury TIPS (Treasury Inflation Protected Securities)

U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal Securities)

Inputs

The J.P. Morgan trading desk acts as a primary dealer in U.S. Treasury securities, and as

such has access to the markets to determine prices based on actual transactions. The desk

also obtains market information through contacts with the broker-dealer community.

Evaluations of Treasury securities by the trading desk are based on supply and demand.

PricingDirect evaluators gather additional market information from other sources in order to

perform their own quality control and consistency checks on the evaluations provided by the

desk.

U.S. Treasury Closes

Bench Price Chg Yield Chg Identifier Coupon Maturity

3MO 0.10000 0.040 0.10141 0.041 912795UL3 0.000 20100401

6MO 0.20000 0.000 0.20298 0.000 912795U66 0.000 20100701

12MO 0.43500 -0.005 0.44245 -0.005 912795UK5 0.000 20101216

2YR 99.80859 0.352 1.09702 0.061 912828ML1 1.000 20111231

3YR 98.56641 -0.012 1.62315 0.005 912828MB3 1.125 20121215

5YR 97.91406 0.047 2.57917 -0.010 912828LZ1 2.125 20141130

7YR 96.54297 0.113 3.31305 -0.019 912828MA5 2.750 20161130

10YR 96.46094 0.266 3.80796 -0.033 912828LY4 3.375 20191115

30YR 95.64062 0.859 4.64605 -0.056 912810QD3 4.375 20391115

Pricing Factors

Supply and demand

Methodology

After performing its quality control checks, PricingDirect delivers the evaluations directly to

clients.

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U.S. Government Agency Debentures and Supranationals

Description

Quasi-government and supranational entities sell unsecured securities to fund their activities.

These agencies include Fannie Mae, Freddie Mac, the Federal Home Loan Bank, the Federal

Farm Credit Bank, the Tennessee Valley Authority, KfW, etc.

Inputs

The J.P. Morgan data services team provides data on bond characteristics such as issuer

name, issue date, coupon and coupon payment schedule, maturity, ratings, call schedule,

original and outstanding amount, etc.

The J.P. Morgan trading desk and other market participants provide evaluations and/or

actual trade data for the actively traded benchmark bonds, as well as callable indicative grids,

based on their observations and trading activities. The trading desk also provides volatilities

for the actively traded callable bonds.

PricingDirect evaluators use models developed by J.P. Morgan research to calculate

additional inputs based on market assumptions provided by traders, and on performance data.

o Using these models, the evaluators determine the spread curve (for bullet bonds) and

the OAS curve (for callable bonds) for actively traded debentures.

o The evaluators may also apply rules based adjustments to their pricing assumptions, as

described below.

Rules Based Adjustments

Using rules based logic developed in conjunction with the trading desk, PricingDirect evaluators

examine reference data such as issuer name, issue size, ratings, maturity, call type and other

features. They may adjust the spread and/or OAS of selected issues based on these features,

liquidity and/or similar market-related factors.

Pricing Factors

Spread/benchmark yield (for bullet bonds), OAS (for callable bonds)

Methodology

PricingDirect evaluators use models developed by J.P. Morgan research as the valuation tool.

PricingDirect evaluators use the income approach, which discounts future cashflows to the net

present value of the security, as the valuation technique.

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U.S. Government Agency and Supranational STRIPs

Description

These securities are zero coupon bonds that are stripped off bonds issued by quasi-government

and supranational entities.

Inputs

The J.P. Morgan data services team provides data on bond characteristics such as issuer

name, issue date, coupon and coupon payment schedule, maturity, ratings, original and

outstanding amount, etc.

The J.P. Morgan trading desk and other market participants provide evaluations and/or

actual trade data for the actively traded benchmark bonds based on their observations and

trading activities.

PricingDirect evaluators use proprietary models developed by J.P. Morgan research to

calculate additional inputs based on market assumptions provided by traders, and on

performance data.

o Using these models, the evaluators determine the spread curve for actively traded

debentures.


described below.



examine reference data such as issuer name, issue size, ratings, maturity, and other features.

They may adjust the spread of selected issues based on these features, liquidity and/or similar

market-related factors.

Pricing Factors

Yield

Methodology




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European Sovereigns and Supranationals

Description

These securities include the following instruments that are issued by sovereign governments in

Europe, including those that are both inside and outside the Euro-zone.

Germany: Bubills, Schätze, Bobls, Bunds

Italy: BOTs, CTZs, BTPs, CCTs

France: BTFs, BTANs, OATs

Great Britain: Conventional Gilts, Index-linked Gilts

Spain: Letras del Tesoro, Bonos del Estado, Obligaciones del Estado

The Netherlands: DTCs, DSLs

Across all countries: supranational institutions and agencies

Inputs

The J.P. Morgan trading desk is one of the world’s largest broker-dealers in European

sovereign and supranational securities, and as such has access to the markets to determine

prices based on actual transactions. The desk also obtains market information through

contacts with the broker-dealer community. Evaluations of European sovereign securities by

the trading desk are based on supply and demand.


perform their own quality control and consistency checks on the information provided by the

desk.

Pricing Factors

Supply and demand

Methodology

After performing its quality control checks, PricingDirect delivers the trader evaluations directly to

clients.

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4. Mortgage-Backed Securities

To Be Announced Securities (TBAs)

Description

TBAs are contracts for the future purchase or sale of agency mortgage-backed securities. The

contract settles on an agreed-upon future date that is associated with the type of the underlying

securities, and may be one, two, or three months in the future. The contract specifies certain

broad characteristics of the underlying securities – agency, term and coupon – but does not

specify the actual agency pools that are to be exchanged at settlement. For the purposes of the

TBA contract, any agency pool that meets the broad definition of the contract is “good delivery”,

and such pool(s) are delivered to holders of the contract at settlement.

Inputs

The J.P. Morgan trading desk makes markets in TBA securities, and as such has access to

the markets to determine prices based on actual transactions. The desk also obtains market

information through contacts with the broker-dealer community. Evaluations of TBA securities

are based on supply and demand.


perform their own quality control and consistency checks on the TBA evaluations provided by

the desk.

Pass-Through Daily Performance Sheet

30-Year TBA

vs. Prior Close vs. Tsy vs. Swp GN30 Dec Jan Feb Mar

3.75 3.75 7.63 3.5% 92-22.4 92-11.4 92-00.4 91-20.2

6.25 3.13 6.25 4.0% 97-04.4 96-25.4 96-14.4 96-03.0

5.50 2.50 5.00 4.5% 100-20.0 100-07.2 99-27.2 99-14.2

3.63 2.00 4.00 5.0% 103-11.1 102-31.1 102-19.1 102-06.1

1.75 1.50 3.13 5.5% 105-08.1 104-28.0 104-18.2 104-07.6

0.75 1.13 2.38 6.0% 105-31.6 105-26.6 105-20.4 105-13.0

-1.00 0.88 1.75 6.5% 106-17.0 106-14.0 106-09.0 106-03.2

vs. Prior Close vs. Tsy vs. Swp FN30 Dec Jan Feb Mar

3.75 3.75 7.63 3.5% 93-07.4 92-27.0 92-14.0 92-01.0

6.25 3.13 6.25 4.0% 97-03.7 96-25.4 96-15.1 96-04.3

5.25 2.50 5.00 4.5% 100-09.3 99-30.4 99-19.1 99-06.7

3.63 2.00 4.00 5.0% 103-01.7 102-23.3 102-11.2 101-30.1

1.75 1.50 3.13 5.5% 105-03.0 104-25.4 104-14.5 104-03.0

0.75 1.13 2.38 6.0% 106-13.4 106-02.6 105-24.7 105-15.1

-0.25 0.88 1.75 6.5% 107-19.6 107-08.6 106-29.1 106-18.6

vs. Prior Close vs. Tsy vs. Swp GD30 Dec Jan Feb Mar

3.75 3.75 7.63 3.5% 92-20.0 92-07.0 91-26.0 91-13.0

6.25 3.13 6.25 4.0% 96-30.2 96-20.0 96-09.7 95-31.1

5.25 2.50 5.00 4.5% 100-07.3 99-28.4 99-17.1 99-05.1

4.00 2.00 4.00 5.0% 102-31.3 102-20.7 102-09.1 101-28.5

1.25 1.50 3.13 5.5% 105-05.4 104-28.0 104-17.3 104-05.3

0.75 1.13 2.38 6.0% 106-16.0 106-05.2 105-27.4 105-16.6

-0.25 0.88 1.75 6.5% 107-17.6 107-06.2 106-26.4 106-12.1

GN/FN and Gold/FN swap prices are based on Dec TBA contracts

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Market Rates and Indices

Benchmarks Price Yield Price Change Yield Change

2yr Tsy 99.80859 1.09702 0.352 0.061

3yr Tsy 98.56641 1.62315 -0.012 0.005

5yr Tsy 97.91406 2.57917 0.047 -0.010

7yr Tsy 96.54297 3.31305 0.113 -0.019

10yr Tsy 96.46094 3.80796 0.266 -0.033

30yr Tsy 95.64062 4.64605 0.859 -0.056

Treasury Prior Yield Current Yield Yield Change

3mo Treasury 0.06084 0.09634 0.0355

6mo Treasury 0.20298 0.19790 -0.0051

1yr Treasury 0.44756 0.44245 -0.0051

2yr Treasury 1.03623 1.09702 0.0608

3yr Treasury 1.61860 1.62315 0.0046

4yr Treasury 2.10393 2.10116 -0.0028

5yr Treasury 2.58926 2.57917 -0.0101

6yr Treasury 2.96048 2.94611 -0.0144

7yr Treasury 3.33170 3.31305 -0.0187

10yr Treasury 3.84111 3.80796 -0.0332

30yr Treasury 4.70162 4.64605 -0.0556

Swap Prior Yield Current Yield Yield Change

1mo Swap 0.23125 0.23094 -0.0003

3mo Swap 0.25063 0.25063 0.0000

6mo Swap 0.43125 0.43438 0.0031

1yr Swap 0.97875 0.99750 0.0188

2yr Swap 1.37800 1.37800 0.0000

3yr Swap 2.01600 2.02000 0.0040

4yr Swap 2.53300 2.54300 0.0100

5yr Swap 2.94600 2.93400 -0.0120

6yr Swap 3.25800 3.25300 -0.0050

7yr Swap 3.49200 3.48600 -0.0060

8yr Swap 3.68400 3.67200 -0.0120

9yr Swap 3.84000 3.82300 -0.0170

10yr Swap 3.97700 3.93700 -0.0400

12yr Swap 4.17900 4.15500 -0.0240

15yr Swap 4.37400 4.33700 -0.0370

20yr Swap 4.50400 4.45200 -0.0520

30yr Swap 4.56200 4.50700 -0.0550

Indices Prior Yield Current Yield Yield Change

COFI 1.25900 1.25900 0.0000

PRIME 3.25000 3.25000 0.0000

1mo Libor 0.23125 0.23094 -0.0003

3mo Libor 0.25063 0.25063 0.0000

6mo Libor 0.43125 0.43438 0.0031

12mo Libor 0.97875 0.99750 0.0188

Pricing Factors

Supply and demand

Methodology

After performing its quality control checks, PricingDirect delivers the evaluations directly to

clients.

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Stipulated To Be Announced Securities (Stip TBAs)

Description



securities, and may be one, two, or three months in the future. In additional to the terms of the

standard TBA contract, which specifies the agency, term and coupon of the underlying securities,

the stipulated TBA contract specifies one or more additional features such as loan-to-value ratio

(LTV), maximum loan balance (LB), geography and/or eligibility under the Making Home

Affordable (MHA) program. In practice, stipulated TBAs are most often defined as having just

one additional feature, although more than one such feature can be specified in the contract.

For the purposes of the stipulated TBA contract, any agency pool that meets the particular set of

specifications in the contract is “good delivery”, and such pool(s) are delivered to holders of the

contract at settlement.

Inputs




are based on supply and demand.



the desk.

PricingDirect clients supply the assumptions in the stipulated TBA contracts for which they

request evaluations.

PricingDirect evaluators use mortgage models developed by J.P. Morgan research to

maintain a payup matrix based on the market assumptions provided by traders and/or other

market participants, performance data, and mortgage model projections.

o Based on these inputs, the evaluators may also apply rules based adjustments to the

payup matrix, as described below.


The payup matrix relates to various characteristics of mortgage-backed securities such as, but

not limited to, weighted average coupon (WAC), weighted average maturity (WAM), agency (i.e.,

Fannie Mae, Freddie Mac, Ginnie Mae), maximum loan balance, loan vintage, loan-to-value ratio

(LTV), geography and prepayment penalties. Based on trade information including payups,

market developments, and trade color received from the J.P. Morgan trading desk for TBA

securities, PricingDirect evaluators derive evaluations for all classes of specified pools.

Pricing Factors

Payup

Methodology


present value of the derivative, as the valuation technique.

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Options on To Be Announced Securities (TBA Options)

Description



securities, and may be one, two, or three months in the future. The contract specifies certain

broad characteristics of the underlying securities – agency, term and coupon – but does not

specify the actual agency pools that are to be exchanged at settlement. For the purposes of the

TBA contract, any agency pool that meets the broad definition of the contract is “good delivery”,

and such pool(s) are delivered to holders of the contract at settlement.

There is also a market for options on TBA contracts. Investors can buy or sell TBA options for

the purpose of portfolio hedging, or to express a view of the market. At present, such options

are traded only on standard TBA contracts, not on stipulated TBAs, which have at least one

additional collateral characteristic specified in the contract, and which are described elsewhere in

this document.

Inputs




are based on supply and demand. The J.P. Morgan desk also makes markets in TBA options,

and provides option volatility in the option pricer that is utilized by PricingDirect.



the desk.

Pricing Factors

TBA prices for a specific agency, term and coupon for a given settlement month; mortgage

prepayment model; option strike price, expiry date and volatility cube.

Methodology

PricingDirect evaluates TBA options using a valuation tool developed by the J.P. Morgan

quantitative research team. TBAs are modeled using the J.P. Morgan prepayment model, and

option volatility is modeled using the SABR method. The model uses forward price, coupon rate

and tenor as inputs, as well as OAS duration, convexity, and other parametric outputs from the

stochastic mortgage model. By using the stochastic process to model the option’s tenor as a

function of the TBA security’s prepayment optionality, PricingDirect’s valuation process properly

accounts for the negative convexity of the contract’s underlying mortgages. PricingDirect

receives the TBA prices from the J.P. Morgan trading desk; the OAS analytics are supported by

the J.P. Morgan quantitative research group.



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Fixed-Rate Pass-Through Certificates (Specified Pools)

Description

A mortgage pass-through security represents a fractional undivided interest in a pool of

residential mortgage loans that meets certain underwriting guidelines. The principal and interest

payments of these securities are implicitly or explicitly guaranteed by government or

government-related agencies such as Fannie Mae, Freddie Mac and Ginnie Mae, and include

different mortgage maturities such as 30-year, 15-year, 20-year, etc.

The respective agency creates a mortgage pass-through, which distributes to investors all

scheduled and prepaid principal and interest from the underlying mortgage loans net of fees

associated with the agency guarantee and loan servicing. If a borrower defaults on a mortgage

and the servicer liquidates the loan at a loss, the agency absorbs this loss and thereby

eliminates credit risk for the investor.

The specified pool market allows for the trading of securities that are perceived to have

incremental value over TBAs due to characteristics such as WAC (low or high), maximum loan

balance, or geographic concentration in one or more states. Specified pool “payups” over the

price for generic (TBA) pools reflect this perceived incremental value, and may differ for each

specified pool depending on the characteristics of the pool, investor demand, and market

conditions.

Inputs

The J.P. Morgan data services team provides detailed collateral information about each

agency pool, including the parameters that are used to define “payups” to TBA prices.

The J.P. Morgan trading desk and other market participants have access to the markets

to determine prices, yields, and other market assumptions through actual traded prices, and

through contacts with the broker-dealer community.


maintain a payup matrix based on the market assumptions provided by traders and/or other

market participants, performance data, and mortgage model projections.

o Based on these inputs, the evaluators may also apply rules based adjustments to the

payup matrix, as described below.


The payup matrix relates to various characteristics of mortgage-backed securities such as, but

not limited to, weighted average coupon (WAC), weighted average maturity (WAM), weighted

average loan age (WALA), agency (i.e., Fannie Mae, Freddie Mac, Ginnie Mae), maximum loan

balance, loan vintage, loan-to-value ratio (LTV), geography and prepayment penalties. Based

on trade information including payups, market developments, and trade color received from the

J.P. Morgan trading desk for TBA securities, PricingDirect evaluators derive evaluations for all

classes of specified pools.

Pricing Factors

Spread, payup, CPR

Methodology

For specified pool evaluations, we calculate spot TBA prices for T+0 settlement, and we may use

distinct assumptions for pools in each of the Fannie Mae, Freddie Mac, Ginnie Mae I and Ginnie

Mae II programs. For each of those mortgage programs, the rules based adjustments are

applied as described in the paragraph above.

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Adjustable-Rate Mortgage Securities (ARMs)

Description

Agency adjustable-rate mortgage securities (ARMs) are pools issued by Fannie Mae, Freddie

Mac and Ginnie Mae, and backed by mortgage loans with interest rates that adjust periodically in

response to changes in a specific index. The coupon on a traditional ARM pool typically begins

to adjust at the first periodic reset date, e.g., six months after origination for a 6-month LIBOR

ARM pool. The coupon for a hybrid ARM pool is fixed for a period that may range between one

and ten years, after which it adjusts on a periodic basis. For example, the coupon on a “5/1

hybrid” will be fixed for five years, and then adjust annually thereafter.

PricingDirect provides evaluations for all types of agency ARMs, including pools with the

following indices:

1-month, 6-month and 1-year LIBOR

1-year, 3-year and 5-year Constant Maturity Treasury (CMT)

6-month Certificate of Deposit (CD)

11th District Cost of Funds Index (COFI)

Inputs

The J.P. Morgan data services team provides all available collateral information for agency

ARM pools.


to determine prices, bond equivalent effective margins (BEEMs) and Z-spreads of actively

traded ARM pools.


calculate additional inputs based on the market assumptions provided by traders, and on

performance data.

o The evaluators determine BEEMs and Z-spreads for sample bonds, using prices received

from the J.P. Morgan trading desk.


described below.



may adjust the BEEM, Z-spreads and/or CPR used to price each bond. This logic is based on

ARM pool characteristics such as, but not limited to, index, margin, reset date, collateral types,

life cap, periodic cap, and loan seasoning.

Pricing Factors

BEEM, Z-spread, CPR

Methodology




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Small Business Administration Pools (SBAs)

Description

The Small Business Administration (SBA), an agency of the U. S. government, provides financial

assistance to businesses through its participating SBA lenders in the form of loan guarantees.

The SBA guarantee generally covers 75%–90% of the outstanding loan and is backed by the full

faith and credit of the U.S. government. Interest rates on SBA loans generally float above the

prime rate. PricingDirect provides evaluations for variable rate SBA pools.

Inputs

The J.P. Morgan data services team provides all available collateral information for SBA

pools.


to determine prices, discount margins and other market assumptions through actual traded

prices, and through contacts with the broker-dealer community.

o The trading desk provides PricingDirect with evaluations for actively traded SBA pools.

PricingDirect evaluators use models developed by J.P. Morgan research to evaluate all

SBA pools based on the market assumptions provided by traders, and on performance data.

o The evaluators determine discount margin and prepayment speeds for the actively traded

SBA pools.


described below.



may adjust the discount margin and CPR for each SBA pool based on reference data such as,

but not limited to, life cap (maximum allowable interest rate over the life of the loan), margin

(percentage point spread over the index) and WAM (weighted average maturity).

Pricing Factors

Discount margin, CPR

Methodology




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Structured Agency Mortgage IO/PO

Description

These agency securities are issued by Fannie Mae, Freddie Mac and Ginnie Mae, and are

backed by mortgage pools issued by the respective agency. They represent rights to interest

only (IO) or principal only (PO) cashflows from the underlying mortgage loans.

Inputs

The J.P. Morgan data services, structuring and research teams provide the following deal,

tranche and collateral information:

o Deal Characteristics: collateral grouping, cashflow waterfall.

o Tranche Characteristics: structure, cashflow window.

o Tranche Type: interest only or principal only.

o Collateral Characteristics: average loan size, WAC, WAM, WALA, geography, etc.

o Historical Performance: CPR.

o Model Projected Performance: CPR.

The J.P. Morgan trading desk and other market participants have access to the market to

determine prices, yields and other market assumptions through actual traded prices, and


o The J.P. Morgan trading desk provides evaluations for “on the run” trust IOs and POs.

These actively traded issues are benchmarks for valuing all other structured IOs and POs.


determine the OAS (option adjusted spread) for the desk’s evaluations of benchmark trust IOs

and POs.


described below.


Using rules-based logic developed in conjunction with the trading desk, PricingDirect evaluators

may adjust the OAS used to price each structured IO/PO. This logic is based on deal and

tranche characteristics such as structure and cashflow waterfall; analytical output from the OAS

model such as, but not limited to, convexity, duration and model projected CPR; and collateral

characteristics such as, but not limited to, loan vintage, coupon, term, WAC, WAM, average loan

size and geography.

For short average life bonds, our evaluations assume forward rates at zero volatility, and use a

prepayment vector from the J.P. Morgan econometric prepayment model.

Pricing Factors

OAS, yield, CPR

Methodology




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Agency Mortgage Inverse IO

Description

These agency securities are issued by Fannie Mae, Freddie Mac and Ginnie Mae, and are

backed by mortgage pools issued by the respective agency. They represent rights to inverse

interest only (IIO) cashflows from the underlying mortgage loans.

Inputs



o Deal Characteristics: collateral grouping, cashflow waterfall.

o Tranche Characteristics: structure, cashflow window.

o Collateral Characteristics: average loan size, WAC, WAM, WALA, geography, etc.

o Historical Performance: CPR.

o Model Projected Performance: CPR.




o The J.P. Morgan trading desk provides evaluations for “on the run” trust IOs. These

actively traded issues are benchmarks for valuing agency mortgage inverse IOs.


determine the OAS (option adjusted spread) for the desk’s evaluations of benchmark trust IOs.


described below.


Using rules-based logic developed in conjunction with the trading desk, PricingDirect evaluators

may adjust the OAS used to price IIOs based upon trust IOs. This logic is based on deal and

tranche characteristics such as structure and cashflow waterfall; analytical output from the OAS

model such as, but not limited to, convexity, duration and model projected CPR; and collateral

characteristics such as, but not limited to, loan vintage, coupon, term, WAC, WAM, average loan

size and geography.

Pricing Factors

OAS, yield, CPR

Methodology




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Collateralized Mortgage Obligations (CMOs)

Agency, Prime Jumbo and Alt-A (Seniors)

Description

CMOs are multi-class securities that are ultimately backed by residential mortgage loans.

However, within this group of securities there is a key distinction between “agency” CMOs and

“non-agency” CMOs. In the first group are securities that are issued by the agencies Fannie

Mae, Freddie Mac or Ginnie Mae, and which are comprised of a group of agency mortgage

pools (i.e., TBA or specified pools, as described earlier). These single-class pools are, in turn,

backed by individual mortgage loans. Investors in agency CMOs do not assume any credit risk,

as potential losses on the underlying residential mortgages would not flow through to them.

Non-agency CMOs differ in two key respects. First, they are in most cases backed by a group of

individual mortgage loans directly, rather than through an intermediate “pooling” of such loans.

Second, and more important, investors in non-agency CMOs assume credit risk. In general, this

credit risk is mitigated in non-agency CMOs through structure: generally either a senior

subordinate “shifting interest” structure whereby lower-rated tranches absorb principal losses, or

an excess spread/overcollateralization structure whereby the CMO has extra cashflow that is

designed to absorb principal losses. In general, non-agency CMOs with higher initial credit

quality (i.e., “prime jumbo” and some “Alt-A”) use the shifting interest structure, while lower

quality Alt-A, as well as subprime, use the excess spread method.

Inputs


tranche and collateral information, as each may be applicable based on whether the bond is

an agency or non-agency CMO:

o Deal Characteristics: shelf, subordination, collateral grouping, cross-collateralization,

triggers, cashflow waterfall.

o Tranche Characteristics: structure, credit enhancement, cashflow window, financial

guarantee (if applicable).

o Tranche Type: sequential, floating rate, inverse floating rate, Planned Amortization Class

(PAC), Target Amortization Class (TAC), Non-Accelerated Senior (NAS), support, accrual

(Z-bond), Accretion Directed (AD), Non-Sticky Jump (NSJ), etc.

o Collateral Characteristics: deal collateral type (agency, prime jumbo or Alt-A), loan vintage,

geography, LTV ratio, FICO score, average loan size, documentation, re-performing loans,

non-performing loans etc.

o Historical Performance: CPR, CDR, severity, and delinquency.

o Model Projected Performance: CPR, CDR, severity and loss.


determine prices, yields, and other market assumptions through actual traded prices, and


o The trading desk provides PricingDirect with prices on bid lists, offerings, and sample

bonds. They also provide current market assumptions about CPR, CDR, and severity for

valuation of non-agency securities, as these parameters may be applicable. For agency

securities, they provide OAS, CPR, and spread information.

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performance data.

o The evaluators determine yields for the sample bonds, using prices received from the J.P.

Morgan trading desk.


described below.



may adjust the nominal spreads, option-adjusted spreads, CPRs, CDRs, and/or severities used

to price each bond. This logic is based on deal and tranche characteristics such as, but not

limited to, shelf, structure, credit enhancement, and the effects of the deal triggers on the

cashflow waterfall; collateral characteristics such as, but not limited to, loan vintage, geography,

LTV ratio, FICO score, average loan size and documentation; actual collateral performance data

such as CPR, CDR, severity and delinquency; and/or model projections for average life, duration,

convexity, and future CPR, CDR, severity, and loss. Such model projections may be compared

to projections for other deals in the same vintage, and as a result one or more pricing factors

may be adjusted.

Pricing Factors

Pricing factors for agency CMOs include CPR, and either nominal spread or OAS.

Pricing factors for non-agency CMOs may include CDR and severity in addition to the above.

Methodology




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Payment Option ARMs (Seniors)

Description

A payment option ARM is a type of mortgage whose coupon rate periodically resets in relation to

a specified index. Additionally, with this type of mortgage the borrower is given the option to

defer principal payments, which may cause the loan to negatively amortize. Typically, the senior

portion of a payment option ARM deal includes multiple tranches rated AAA at origination, with

varying original weighted average lives. The bonds’ interest rates adjust monthly according to a

specified margin over one month LIBOR or the 12 month MTA.

Inputs







o Tranche Type: super senior, senior mezzanine, junior mezzanine or pass-through.

o Collateral Characteristics: deal collateral type (payment option ARM), loan vintage,

geography, LTV ratio, FICO score, average loan size, documentation, etc.


o Model Projected Performance: CPR, CDR, severity, and loss.






valuation, as these parameters may be applicable.



performance data.




described below.



may adjust the CPRs, CDRs, and/or severities used to price each bond. This logic is based on

deal and tranche characteristics such as, but not limited to, shelf, structure, credit support, and

the effects of the deal triggers on the cashflow waterfall; collateral characteristics such as, but

not limited to, loan vintage, geography, LTV ratio, FICO score, average loan size and

documentation; actual collateral performance data such as CPR, CDR, severity and delinquency;

and/or model projections for average life, duration, convexity, and future CPR, CDR, severity,

and loss. Such model projections may be compared to projections for other comparable deals,

and as a result one or more pricing factors may be adjusted.

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Evaluators determine the yield of a security based on factors including, but not limited to, loan

vintage, credit support, type of cashflow, collateral characteristics and deal and/or tranche

performance.

Pricing Factors

Yield, CPR, CDR, severity

Methodology




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Prime Jumbo and Alt-A Fixed/ARM and Payment Option ARM (Subordinates)

Description

Subordinate tranches in a non-agency CMO have varying cashflow windows and risk profiles,

depending on their position in the cashflow waterfall, collateral performance, the deal’s loss and

delinquency triggers, and other factors.

Inputs





o Tranche Characteristics: structure, credit enhancement, cashflow window.

o Tranche Type: subordinate.

o Collateral Characteristics: deal collateral type (prime fixed or ARM, Alt-A fixed or ARM, or

payment option ARM), loan vintage, geography, LTV ratio, FICO score, average loan size,

documentation, re-performing loans, non-performing loans etc.


o Model Projected Performance: CPR, CDR, severity.









performance data.

o The evaluators determine yields for the sample bonds, using prices received from the

J.P. Morgan trading desk.


described below.













performance.

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Pricing Factors


Methodology




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Subprime Mortgage-Backed Second Lien and HELOC (Seniors)

Description

A subprime mortgage-backed deal contains mortgages with an average FICO (credit) score of

approximately 600 to 675. The collateral primarily consists of first lien residential mortgages, but

may also include second/junior liens, home equity lines of credit, or similar assets. The

underlying mortgages may be fixed rate or adjustable rate. Typically, the senior structure of a

subprime deal includes multiple tranches rated AAA at origination, with original weighted

average lives of 1 year, 2 years, 3 years, and a longer last cashflow bond. Each senior bond’s

coupon may be fixed rate or float off of a specified index.

Inputs







o Tranche Type: pass-through, with original weighted average life of 1, 2, or 3 years; and

last cashflow bond.

o Collateral Characteristics: deal collateral type (subprime), loan vintage, geography, LTV

ratio, FICO score, average loan size, documentation, etc.

o Historical Performance: CPR, CDR, severity, delinquency and loss.










performance data.




described below.











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performance.

Pricing Factors


Methodology




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Non-Performing and Re-performing

Description

Non-performing loans (NPL) are backed by seasoned collateral that are highly delinquent. Most

NPLs are characterized by substantial credit enhancement with an early redemption,

incentivizing the issuer to call the deal after 3 years or earlier. Re-performing loans (RPL) are

backed by loans that were previously delinquent and are currently paying.

Inputs



o Deal Characteristics: shelf, subordination, collateral grouping, cross-collateralization, early

redemption, cashflow waterfall.

o Tranche Characteristics: rating, structure, credit enhancement, cashflow window, financial


o Tranche Type: pass-through, with original weighted average life of 1, 2, or 3 years; and

last cashflow bond.

o Collateral Characteristics: deal collateral type (NPL/ RPL), loan vintage, geography, LTV

ratio, FICO score, average loan size, documentation, etc.






o The trading desk and other market participants provide PricingDirect with prices on bid lists,

offerings, and sample bonds in addition to coverage on new issue primary market. They

also provide current market assumptions about CPR, CDR, and severity for valuation, as

these parameters may be applicable.



performance data.


Morgan trading desk and other market participants.


described below.





expected redemption the effects of the deal triggers on the cashflow waterfall; collateral

characteristics such as, but not limited to, loan vintage, geography, LTV ratio, FICO score,

average loan size and documentation; actual collateral performance data such as CPR, CDR,

severity and delinquency; and/or model projections for average life, duration, convexity, and

future CPR, CDR, severity, and loss. Such model projections may be compared to projections

for other comparable deals, and as a result one or more pricing factors may be adjusted.

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performance.

Pricing Factors


Methodology




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Subprime Mortgage-Backed Second Lien and HELOC (Subordinates)

Description

A subprime mortgage-backed deal contains mortgages with an average FICO (credit) score of

approximately 600 to 675. The collateral primarily consists of first lien residential mortgages, but

may also include second/junior liens, home equity lines of credit, or similar assets. The

underlying mortgages may be fixed rate or adjustable rate. Typically, the subordinate securities

in a subprime deal include tranches with rating of less than AAA at origination; these tranches

provide credit support to the senior tranches, thus forming a foundation for the deal’s capital

structure. Each subordinate bond’s coupon can be fixed rate or floating off of a specified index.

Inputs





o Tranche Characteristics: structure, credit enhancement, cashflow window.

o Tranche Type: pass-through or sequential.

o Collateral Characteristics: deal collateral type (subprime), loan vintage, geography,

LTV ratio, FICO score, average loan size, documentation, etc.











performance data.




described below.




deal and tranche characteristics such as, but not limited to, shelf, structure, credit support,

position in the capital structure, and the effects of the deal triggers on the cashflow waterfall;

collateral characteristics such as, but not limited to, loan vintage, geography, LTV ratio, FICO

score, average loan size and documentation; actual collateral performance data such as CPR,

CDR, severity, delinquency and loss; and/or model projections for average life, duration,

convexity, CPR, CDR, severity, and expected collateral loss as compared to comparable vintage

performance. Such model projections may be compared to projections for other comparable

deals, and as a result one or more pricing factors may be adjusted.

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performance.

Pricing Factors


Methodology




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Commercial Mortgage Backed Securities (CMBS)

Description

Commercial mortgage backed securities (CMBS) are backed by loans on commercial real estate.

Typically these consist of retail shopping malls (both anchored and unanchored), industrial and

office properties, multi-family housing and lodging (hotels, motels, etc.). PricingDirect evaluates

CMBS conduit (fixed rate) deals with ratings originally rated from AAA to BBB-. We do evaluate

selectively single loan deals where we get enough loan level information.

Inputs

The J.P. Morgan data services and structuring teams provide the following deal, tranche

and collateral information:

o Deal Characteristics: shelf, subordination, triggers, cashflow waterfall.

o Tranche Characteristics: structure, credit enhancement, rating, cashflow window, financial


o Tranche Type: interest-only (IO), super senior, junior mezzanine, subordinate.

o Collateral Characteristics: loan vintage, geography, LTV ratio, debt service coverage ratio

(DSCR), property type, etc.

o Historical Performance: defeasance and delinquency.





bonds. They also provide current market assumptions about spread for valuation.

PricingDirect evaluators use the following additional input data to complement the

benchmark spreads received from the desk:

o The evaluators independently gather information from actual trades, bid lists, offering

sheets as well as from other market participants (such as customer insight/opinion).


described below.



may adjust the yields and/or spreads used to price each bond. This logic is based on deal and

tranche characteristics such as, but not limited to, shelf, structure, average life, credit

enhancement, rating, extension risk, and the effects of deal triggers on the cashflow waterfall;

collateral characteristics such as, but not limited to, DSCR, LTV ratio, vintage, property type,

location, seasoning and maturity; and actual collateral performance such as defeasance,

delinquency and special servicing. Such adjustments may also be based on current market

movements and trading color.

Pricing Factors

Yield, spread, average life, CPY, CDR, severity

Methodology




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Delegated Underwriting and Servicing Pools (DUS)

Description

DUS pools are Fannie Mae mortgage-backed securities secured by income-producing

multifamily mortgage loans. These securities may contain one loan or multiple loans, and may

also be structured as mega pools. Interest on DUS bonds can be calculated on either an

Actual/360 or 30/360 basis.

DUS securities are familiarly known as 10/9.5 or 7/6.5. A 10/9.5 security has a 10-year stated

maturity and a 9.5-year principal lockout period. Similarly, a 7/6.5 security has a 7-year stated

maturity and a 6.5-year principal lockout period.

Inputs

The J.P. Morgan data services team provides all available collateral information for DUS

pools.


to determine prices and other market assumptions through actual traded prices, and through

contacts with the broker-dealer community.

o The trading desk provides PricingDirect with evaluations for actively traded DUS pools.

PricingDirect evaluators use models developed by J.P. Morgan research to evaluate all

DUS pools based on the market assumptions provided by the traders, and on performance

data.

o The evaluators determine prepayment speeds for actively traded DUS pools using the

models as well as trader input.


described below.



may adjust the spread and prepayment assumption for each DUS pool based on reference data

such, but not limited to, maturity and lockout period.

Pricing Factors

Spread, CPY

Methodology




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GNMA Project Loan Securities

Description

While similar in structure to agency CMOs, Ginnie Mae project loan securities are backed by

commercial loans. The collateral features a U.S. government guarantee for 100% of the

principal and interest due. These deals typically consist of four to six fixed-rate, sequential pay

classes of varying duration and an Interest Only class.

Inputs

The J.P. Morgan data services, structuring and research teams provide the following


o Deal Characteristics: shelf, subordination, cashflow waterfall.

o Tranche Characteristics: structure, cashflow window, financial guarantee.

o Tranche Type: sequential, accrual (Z-bond), Interest Only (IO).

o Collateral Characteristics: deal vintage, geography, LTV ratio, property type, average loan

size, etc.

o Historical Performance: prepayments, defaults, special servicing, etc.

o Model Projected Performance: CPJ.


determine prices, yields, and other market assumptions through actual traded prices and



bonds. They also provide CPJ and spread information.



performance data.


J. P. Morgan trading desk.

o The evaluators may also apply rules based adjustments to their pricing assumptions as

described below.



may adjust the nominal spreads and CPJ used to price each bond. This logic is based on deal

and tranche characteristics such as, but not limited to, deal vintage and structure; and/or

collateral characteristics such as, but not limited to, loan vintage, geography and LTV ratio.

Pricing Factors

Spread, CPJ

Methodology




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Hard-to-Value Securities (HTV)

Description

Hard-to-value (HTV) securities are non-agency mortgage products that are particularly difficult to

structure, model and value. HTV securities may fall into any non-agency product category,

including prime jumbo as well as Alt-A and subprime. While the inclusion of a particular type of

security in this category may depend on market conditions, we generally classify a mortgage-

related security as HTV if it falls into one or more of the following categories:

Its original rating was below AAA;

It is a particularly illiquid security;

It is a resecuritization of non-agency RMBS;

It is a bond backed by non-US mortgages.

Agency risk transfer bonds (For e.g. STACR, CAS)

Single Family Rentals (SFR deals)

Methodology

The methodologies used to generate HTV evaluations are different for each product category,

and are based on the processes described in the appropriate sections of this booklet. For each

product that is classified as HTV, PricingDirect evaluators work very closely with the trading desk

to determine appropriate assumptions based on the security’s position in the capital structure, its

current delinquencies, current and projected losses, the effect of deal triggers, etc. This is by

definition a painstaking process that requires considerable attention for each security, given the

multiplicity of relevant variables (e.g., a deal’s delinquency pipeline, current credit support,

historical losses and future expectations, etc.). In addition, other common features of

PricingDirect’s HTV valuation process are loan level data collection on the underlying collateral,

structuring of frequently complex cashflows, and comprehensive modeling of prepayments,

defaults, severities and losses. The figure below explains the key aspects of this process with

respect to a non-agency RMBS resecuritization.

Structuring and Modeling

The HTV valuation process uses actual historical performance data, model-calculated input (e.g.,

loss projections) and market observable input that may be provided by the trading desk. Model

projections are a key element in determining inputs to HTV evaluations even if the models are

not explicitly used.

RMBS

Resecuritization

Structured

Securities

Loans

RMBS

Resecuritization

Structured

Securities

LoansSubordinate

Mezzanine

Senior

Prepayments

Defaults

Cashflows

National

Models (Calibrated Monthly)

Bottom-Up

Top-Down

MSA (2)

HPA (1)

Assumptions

Structuring

1 Home Price Appreciation2 Metropolitan Statistical Area

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Non-Agency RMBS Resecuritizations

Among the most complex examples of HTV securities are resecuritizations of non-agency

residential mortgage-backed securities. For these instruments, PricingDirect evaluators first

analyze the performance of the underlying bonds, across the dimensions of voluntary CPR, CDR

and severity. They then determine appropriate future assumptions for each variable based on

past history, subject to upper and lower limits that have been defined in conjunction with

mortgage research and/or the trading desk, as well as current market conditions. Finally, they

flush the existing delinquency pipeline of each underlying bond over an appropriate interval.

Once the cashflows have been defined in this manner, evaluators determine DM or yield for

each tranche of the resecuritization based on a similar analysis of the underlying bonds. This

analysis takes into account the credit support provided by the structure, as well as that provided

by the collateral. Finally, any of these assumptions may be modified based on news items

pertaining to each underlying structure, the resecuritization itself, or the market in general.

Loan Level Data Collection and Modeling

J.P. Morgan, as a specialist in mortgage related products, maintains extensive databases

including history on millions of loans and securities. This is actual historical data collected by

various agencies and reported monthly, and it is used in modeling prepayment, default and

severity rates for a wide variety of collateral types.

Among the resources used by PricingDirect in its HTV evaluations is the home price model that

has been developed by J.P. Morgan research, and which is based on Case-Shiller/Fiserv data.

The home price model takes as input a vector of future home price changes on a national level,

and translates that national assumption down to the MSA (Metropolitan Statistical Area) level by

using a variety of factors that include future forecasts of interest rates, as well as income,

employment and population forecasts at the MSA level. The output is a highly robust estimate

that is in turn used as an input to the prepayment, default and severity model, where projections

are performed at the loan level. The advantage of this approach is that projections of security

performance are based on a granular—and therefore realistic—assessment of the level of

available home equity in each geographical area on a zip code level. In the current environment,

such an approach is far superior to a “one size fits all” blanket assumption for future home prices

across all geographic regions.

The suite of available prepayment, default and severity models spans all collateral types, from

prime jumbo, to Alt-A, and subprime, fixed and adjustable-rate including hybrids and option

ARMs, etc. All models in the non-agency space operate on the loan level.

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European Mortgage-Backed Securities (MBS)

European Prime and Non-Prime MBS; UK MBS (Prime, Non-conforming,

Buy-to-let)

Description

These are multi-class securities backed by residential mortgage loans originated in continental

Europe and in the UK. Credit risk is mitigated through structure: generally either a senior

subordinate “shifting interest” structure whereby lower-rated tranches absorb principal losses, or

an excess spread/overcollateralization structure which provides extra cashflow that is designed

to absorb principal losses.

Inputs







o Tranche Type: sequential, floating rate.

o Collateral Characteristics: deal collateral type, loan vintage, geography, documentation,

credit quality, etc.








PricingDirect evaluators utilize trader color, mortgage research reports and data, and deal

performance statistics to determine their CPR, CDR, severity and yield inputs for each deal.

They run those assumptions using industry standard mortgage cashflow models.




described below.



may adjust the yields, CPRs, CDRs, and/or severities used to price each bond. This logic is

based on deal and tranche characteristics such as, but not limited to, shelf, structure, credit

enhancement, and the effects of the deal triggers on the cashflow waterfall; collateral

characteristics such as, but not limited to, loan vintage, geography, average loan size and

documentation; and/or actual collateral performance data such as CPR, CDR, severity and

delinquency.

Pricing Factors


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Methodology

PricingDirect evaluators use industry standard cashflow models as the valuation tool.



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Australian Mortgage-Backed Securities (MBS)

Description

These are multi-class securities backed by residential mortgage loans originated in Australia.

Credit risk is mitigated through structure: generally either a senior subordinate “shifting interest”

structure whereby lower-rated tranches absorb principal losses, or an excess

spread/overcollateralization structure which provides extra cashflow that is designed to absorb

principal losses. Australian mortgages are predominantly (~65%) considered prime. Loans

classified as low-doc/ no-doc comprise most of the remainder, while non-conforming have a very

small market share.

Inputs







o Tranche Type: sequential, floating rate.

o Collateral Characteristics: deal collateral type, loan vintage, geography, documentation,

credit quality, etc.








PricingDirect evaluators utilize trader color, mortgage research reports and data, and deal

performance statistics to determine their CPR, CDR, severity and yield inputs for each deal.

They run those assumptions using industry standard mortgage cashflow models.




described below.






characteristics such as, but not limited to, loan vintage, geography, average loan size and

documentation; actual collateral performance data such as CPR, CDR, severity and delinquency.

Pricing Factors


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Methodology




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5. Asset-Backed Securities

Autos

Description

An auto ABS is an asset-backed security that is collateralized by automobile loans or leases

made to borrowers. These bonds have either fixed or floating rate coupons, an average life of

one to three years at origination, and may be insured by a third party guarantor.

Inputs



o Deal Characteristics: shelf, series, subordination, cross-collateralization, triggers, cashflow

waterfall, initial interest spread, reserve amount (if applicable).

o Tranche Characteristics: structure, coupon type (fixed or floating), average life, credit

enhancement, cashflow window, financial guarantee (if applicable).

o Collateral Characteristics: prime, near prime, or subprime.

o Historical Performance: prepayments, delinquency, severity.


determine prices, discount margins, and other market assumptions through actual traded



bonds. They also provide current market assumptions about average life spreads and

discount margins for valuation.

PricingDirect evaluators may apply rules based adjustments to their pricing assumptions, as

described below.



may adjust the average life spread and/or discount margin used in each bond’s evaluation,

based on deal and tranche characteristics such as, but not limited to, shelf, structure, original

and/or current rating, average life, cashflow waterfall and financial guarantee (if applicable).

Pricing Factors

Discount margin, or average life spread and prepayment rate

Methodology




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Credit Cards

Description

A credit card ABS is an asset-backed security that is collateralized by credit card receivables.

These bonds have either fixed or floating rate coupons. Credit card ABS have a soft bullet

maturity, meaning the bond is expected to receive a single principal payment at maturity.

Inputs



o Deal Characteristics: shelf, series, subordination cross-collateralization, and triggers.

o Tranche Characteristics: structure, coupon type (fixed or floating), average life and credit

enhancement.

o Collateral Characteristics: prime, near prime, or subprime.

o Historical Performance: prepayments, delinquency, severities, excess spread, portfolio

yield.




o The trading desk provides PricingDirect prices on bid lists, offerings, and sample bonds.

They also provide market assumptions for average life spreads and discount margins,

based on shelf, original rating and average life.


described below.






Pricing Factors

Discount margin or average life spread

Methodology




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Manufactured Housing

Description

Manufactured housing securities are backed by mortgages on single family homes constructed

on a chassis at a factory and shipped in one or more sections to a housing site. The loan types

are predominately fixed rate with 15 to 20 or 25 to 30-year amortization schedules. The actual

securities have either a fixed rate or floating rate coupon.

Inputs



o Deal Characteristics: shelf, subordination, triggers, cashflow waterfall.



o Tranche Type: Senior or subordinate.

o Collateral Characteristics: deal collateral type (manufactured housing), loan vintage,

geography, LTV ratio, FICO score, average loan size, documentation, etc.

o Historical Performance: CPR, CDR, severity, loss and delinquency.






valuation.



performance data.




described below.






characteristics such as, but not limited to, loan vintage, geography, LTV ratio, FICO score,

average loan size and documentation; and/or actual collateral performance data such as CPR,

CDR, severity, loss and delinquency.



performance.

Pricing Factors


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Methodology




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Student Loans

Description

Student loan ABS are secured by FFELP (or government-guaranteed) student loans or private

label student loans. These securities typically employ one of the following forms of credit

enhancement:

External credit enhancement:

o For FFELP loans, through the U.S. government’s guarantee of at least 97% of principal,

depending on the date of loan origination.

o For private label loans, through an insurance wrap.

Internal credit enhancement:

o Excess spread.

o Reserve funds.

o Over-collateralization (which refers to the parity ratio of total assets over total liabilities).

o Senior/subordinate structure.

Inputs



o Deal Characteristics: shelf, series, subordination.

o Tranche Characteristics: structure, coupon type (fixed versus floating), and credit

enhancement.

o Historical Performance: prepayments, delinquency, excess spread.



through contacts with the broker-dealer community. The trading desk provides PricingDirect

with evaluations of actively traded student loan ABS, as well as spreads for benchmark

securities in the sector.

PricingDirect evaluators may apply rules based adjustments to their pricing and spread

assumptions, as described below.



adjust spreads for securities based on factors including, but not limited to, shelf, collateral type

(FFELP or private label), capital structure, bond rating, and average life. In addition,

PricingDirect evaluators may further adjust evaluations based on factors including, but not

limited to, current and/or historical parity ratio, and student status (in school, grace period,

deferment, forbearance, repayment, claim).

Pricing Factors

Spread

Methodology




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UK and European Auto Loans, Student Loans, Consumer Loans and

Credit Cards

Description

This category includes asset-backed securities that are collateralized by automobile loans or

leases, student loans, credit card receivables and consumer loans made to borrowers across

continental Europe and in the UK. These bonds have either a fixed or a floating rate coupon and

a relatively short average life, and may be insured by a third party guarantor.

Inputs



o Deal Characteristics: shelf, series, subordination, cross-collateralization, triggers, cashflow

waterfall, initial interest spread, reserve amount (if applicable).

o Tranche Characteristics: structure, coupon type (fixed or floating), average life, credit

enhancement, cashflow window, financial guarantee (if applicable).

o Collateral Characteristics: prime or near prime.

o Historical Performance: prepayments, delinquencies, defaults, severities.


determine prices, discount margins, and other market assumptions through actual traded



bonds. They also provide current market assumptions about average life spreads and

discount margins for valuation.


described below.






Pricing Factors

Discount margin, or average life spread and prepayment rate

Methodology




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6. Collateralized Loan and Debt Obligations

Broadly Syndicated and Middle Market Structures (CLOs)

Small and Medium Enterprise Structures (SME CLOs)

Description

A collateralized loan obligation (CLO) is backed by portfolio of predominantly high yield loans.

The collateral varies based on the type of deal. Broadly syndicated deals consist primarily of

senior secured loans of large cap companies, while middle market deals consist of small to mid

cap company loans, for example business loans. In most cases, the collateral in CLOs is

dynamic and is managed by a collateral manager. CLO tranches and collateral may be either

fixed rate or floating rate off of a specified index. Tranches with original ratings less than AAA,

the subordinate tranches, provide credit support to the senior tranches.

PricingDirect can provide evaluations for US and European CLOs.

Inputs

The J.P. Morgan data services and structuring teams, and third party data sources,

provide the following deal, tranche and collateral information:

o Deal Characteristics: collateral manager, collateral type, deal vintage.

o Tranche Characteristics: interest coverage, market value overcollateralization,

overcollateralization cushion, PIK feature, subordination, turbo feature.

o Tranche Type: fixed/float coupon, original/current ratings.

o Collateral Characteristics: already defaulted recovery, average loan portfolio price,

defaulted assets, deal collateral type (loan type), lien concentration, structured finance

concentration, loan ratings, loan vintage, weighted average coupon, etc.

o Model Projected Performance: CPR, CDR, reinvestment profile, severity.





bonds. They also provide current market levels for different rating ranges.

PricingDirect evaluators use cashflow models developed by the research team to create

stress vectors and other outputs, which are then used to calculate additional inputs based on

the market assumptions provided by traders, and on performance data.

o The evaluators determine spread and/or dollar price for the sample bonds, using data

received from the J.P. Morgan trading desk.


described below.



may adjust the spread used to price each bond. This logic is based on deal and tranche

characteristics such as, but not limited to, coupon, structure, subordination, market value

overcollateralization, overcollateralization cushion, interest coverage test, original and current

rating, event of default language, collateral manager tiering, turbo features, weighted average life,

historical payments, and the effects of the deal triggers on the cashflow waterfall; collateral

characteristics such as, but not limited to, average collateral portfolio price, size of CCC rated

bucket, lien concentration, industry concentration, defaulted assets, and average defaulted

recovery.

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Pricing Factors

DM, yield, CPR, CDR, severity

Methodology




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7. Corporate Securities

Investment Grade Corporate Bonds

Description

Nationally recognized statistical rating organizations classify corporate debt as investment grade

when it falls within the following ranges:

Moody’s: AAA to Baa3;

S&P/Fitch: AAA to BBB-.

PricingDirect’s evaluation methodology divides investment grade corporate debt instruments into

two categories: bullet bonds and bonds with embedded options such as calls, puts, step-ups and

sinking funds. As noted below, certain details of the evaluation process differ for bullet bonds,

as compared to bonds with embedded options.

Inputs

The J.P. Morgan data services and research teams provide indenture information for

investment grade bonds.




PricingDirect evaluators use real time color from the above sources to construct and

maintain yield curves for each investment grade issuer. These curves may be further

differentiated by rating and seniority.

o For bullet bonds, PricingDirect evaluators use the appropriate issuer curve to price each

bond. In addition, the evaluators may maintain more generic yield curves for industry

sectors.

o For bonds with embedded options, Pricing Direct evaluators leverage a rigorously

reviewed, tested, and approved J.P. Morgan corporate bond evaluation model to calculate

the option adjusted spread (OAS) on selected benchmark issues. This model also

accounts for any market volatility.


described below.


In order to account for differences among bonds having the same issuer, rating and seniority,

PricingDirect evaluators may adjust their spread assumptions based on coupon and/or maturity.

For each bond that is evaluated, the nominal or option adjusted spread (depending on the type

of bond) may be adjusted higher or lower based on one or both of the above factors. In addition,

spreads may be adjusted for liquidity or other similar market factors.

Pricing Factors

Nominal spread for bullet bonds, and OAS for bonds with embedded options.

Methodology

Bullet bonds are evaluated using a spread to U.S. Treasury securities. The evaluation is

based on the current profile of the bond, rather than its original classification. For example,

bonds with expired options are treated as bullet bonds.

Bonds with embedded options are evaluated using the OAS methodology.

In both cases, PricingDirect evaluators use models developed by J.P. Morgan research as the

valuation tool. PricingDirect evaluators use the income approach, which discounts future

cashflows to the net present value of the security, as the valuation technique.

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Investment Grade Floater Bonds

Description

Nationally recognized statistical rating organizations classify corporate debt as investment grade

when it falls within the following ranges:

Moody’s: AAA to Baa3;

S&P/Fitch: AAA to BBB-.

PricingDirect’s evaluation methodology evaluates investment grade bullet corporate floater debt

instruments. We currently evaluate instruments which are indexed to 1 month Libor, 3 Month

Libor, 6 month Libor and 3 Month T-Bill. We evaluate floating rate debt instruments from

corporate issuers and supranational entities such as Fannie Mae (FNMA), Federal Home Loan

Mortgage Corp (FHLMC), Federal Home Loan Bank (FHLB), Federal Farm Credit Bank (FFCB),

and International Bank for Reconstruction and Development (IBRD).

Inputs


investment grade bonds.





maintain yield curves for each investment grade issuer. These curves may be further

differentiated by rating and seniority.

o PricingDirect evaluators use the appropriate issuer curve to price each bond. In addition,

the evaluators may maintain more generic yield curves for industry sectors.


described below.



PricingDirect evaluators may adjust their spread assumptions based on coupon and/or maturity.

For each bond that is evaluated, discount margin may be adjusted higher or lower based on

floating index and capital structure. In addition, spreads may be adjusted for liquidity or other

similar market factors.

Pricing Factors

Discount margin spread is used for bullet bonds.

Methodology

Floater bonds are evaluated using a discount margin spread to the underlying index. The

evaluation is based on the current profile of the bond, rather than its original classification.

For example, bonds with expired options are treated as bullet bonds.




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High Yield Corporate Bonds

Description

Nationally recognized statistical rating organizations classify corporate debt as high yield when it

falls within the following statistical ranges:

Moody’s: Ba1 to D;

S&P/Fitch: BB+ to D.

Inputs

The J.P. Morgan data services and research teams provide indenture information for high

yield bonds.




o The trading desk provides PricingDirect with indicative prices for various liquid high yield

bonds, and also for bonds that have defaulted.

o Other market participants provide transacted prices on specific bonds and bond indices, as

well as bid lists and general market color.

PricingDirect evaluators use models developed by J.P. Morgan research to calculate

additional inputs based on market data and assumptions.



o Using real time color obtained from the J.P. Morgan trading desk and other market

participants, PricingDirect evaluators maintain yield curves for each issuer. In addition,

these curves may be further differentiated by rating and seniority.

o If a company has defaulted, it is not possible to perform a discounted cashflow analysis on

its bonds, so PricingDirect evaluators use the trading desk price across all maturities of

bonds in each seniority bucket.


described below.



PricingDirect evaluators may adjust their assumptions based on coupon, maturity and/or the

presence of embedded options. For each bond that is evaluated, the yield may be adjusted

higher or lower based on the coupon and/or maturity. For bonds with embedded options,

evaluators determine the price both with and without the option; the price without the option is

the “base price”. In the case of bonds with calls, the final evaluation is the lesser of “base price”

and “price with call”. In the case of bonds with puts, the final evaluation in the greater of “base

price” and “price with put.”

Pricing Factors

Yield

Methodology




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European Investment Grade and High Yield Corporate Bonds

European Covered Bonds

Description

PricingDirect provides evaluations for European investment grade and high yield corporate

bonds. The distinction between these two classifications may be made based on seniority, the

credit rating from a recognized statistical rating organization, market liquidity, and/or other

factors. In addition, PricingDirect provides evaluations on European covered bonds.

PricingDirect’s evaluation methodology divides European corporate debt instruments into two

categories: bullet bonds and bonds with embedded options such as calls, puts, step-ups and

sinking funds. As noted below, certain details of the evaluation process differ for bullet bonds,

as compared to bonds with embedded options.

Inputs


European investment grade and high yield corporate bonds, as well as covered bonds.


determine prices, yields, z-spreads and other market assumptions through actual traded


PricingDirect evaluators use real time z-spreads and market color from the above sources

to construct and maintain credit curves for each corporate bond issuer. These curves may be

further differentiated by country of issuance, rating, seniority and/or other factors. The

evaluators also gather additional market information from other sources in order to perform

their own quality control and consistency checks on the information provided by the desk.

o For bullet bonds, PricingDirect evaluators use the J.P. Morgan bullet corporate bond

evaluation model, and the appropriate issuer credit curve, to price each bond.

o For bonds with embedded options, PricingDirect evaluators use the J.P. Morgan

corporate bond OAS (option adjusted spread) evaluation model, and the appropriate issuer

credit curve, to price each bond.


described below.


In order to account for differences among bonds having the same issuer, rating and seniority

and/or other characteristics, PricingDirect evaluators may adjust their spread assumptions based

on one or more of such factors. For each bond that is evaluated, the z-spread or option adjusted

spread (depending on the type of bond) may be adjusted higher or lower based on one or both

of the above factors. In addition, spreads may be adjusted for liquidity or other similar market

factors.

Pricing Factors

Z-spread for bullet bonds; OAS for bonds with embedded options

Methodology

Bullet bonds are evaluated using the z-spread to the appropriate benchmark swap curve.

The evaluation is based on the current profile of the bond, rather than its original classification.

For example, bonds with expired options are treated as bullet bonds.

Bonds with embedded options are evaluated using the OAS methodology.

In both cases, PricingDirect evaluators use models developed by J.P. Morgan research as the

valuation tool. PricingDirect evaluators use the income approach, which discounts future

cashflows to the net present value of the security, as the valuation technique.

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Emerging Market Bonds

Description

While there is no generally accepted distinction between emerging and developed markets,

countries are classified in one of these categories largely on the basis of their sovereign rating.

Emerging market bonds, issued by either sovereign governments or emerging market

corporations, generally have lower ratings from the credit rating agencies, and are associated

with one or more inherent risks such as political uncertainty, economic uncertainty, imperfect

fundamental data or limited remedies in the event of default.

Inputs


emerging market sovereign and corporate bonds.




o The trading desk provides market color, evaluations and/or actual trade data for bonds

based on their observations and trading activity.

o PricingDirect also receives information from other market participants via electronic trading

platforms such as TRACE, and/or third-party vendors. The information that PricingDirect

receives from other sources may be used to supplement the information obtained from the

J.P. Morgan trading desks, or to perform quality control on that information, or for a

combination of both.

PricingDirect evaluators use real time color from the above sources to monitor how

emerging markets bonds are being priced throughout the day. Valuation models may be run

multiple times during the day, and pricing assumptions may be adjusted based on market

conditions. Further differentiation may also be made within the emerging markets universe

based on country of risk, currency, issuer, industry, liquidity or other factors.


Using all available information from the above sources, PricingDirect evaluators may adjust

prices as necessary at each valuation snapshot based on new market color and/or news items,

as well as on other factors such as movements in interest rate curves, or geopolitical events.

Pricing Factors

Yield

Methodology




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8. Money Market Instruments

Corporate and Asset-Backed CP, Repurchase Agreements (RPs),

Certificates of Deposit (CDs), and Bankers’ Acceptances (BAs)

Description

Corporate and asset-backed commercial paper (CP) is issued by institutions wishing to secure

short-term financing for their activities, including the acquisition of working capital. CP programs

can be further distinguished by how the paper is placed (dealer placed or direct issue), and by

whether or not it is asset-backed. Repurchase agreements (RPs) also allow institutions to obtain

short-term financing, and their value is dependent on the quality of the collateral used in the

transaction, as well as the seller’s credit standing (i.e., counterparty risk). Certificates of deposit

(CDs) are issued by financial institutions in order to attract deposits from other institutional

buyers. Bankers’ acceptances (BAs) are short-term instruments issued by a non-financial firm

and guaranteed by a bank.

Inputs

The J.P. Morgan data services and research teams provide available information for

money market instruments.





maintain yield curves for each type of money market program (CP, RPs, CDs, and BAs). The

evaluators use trading color to construct a “generic” curve that can be applied to a large

number of similar money market instruments within a given program. Trading color is

collected based on an appropriate set of attributes, as described below.

o For corporate and asset-backed CP, the evaluators use bid lists and other trader color to

construct curves that capture the impact of program type (dealer placed or direct issue;

asset-backed or corporate), term and issuer credit tier.

o For repurchase agreements (RPs), the evaluators use bid lists and other trader color to

construct curves that capture the impact of collateral quality and counterparty risk. A

particular repo is evaluated based upon term of the repo, collateral type and the dealer.

o For certificates of deposit (CDs), the evaluators use bid lists and other trader color to

construct curves that capture the impact of term, issuer credit tier, and bank type

(yankee/euro/domestic).

o For banker’s acceptances (BAs), the evaluators use bid lists and other trader color to

construct curves that capture the impact of term and the credit standing of the guarantor.

o In general, the curves generated by these processes will apply to a smaller number of

instruments than each program’s “generic” curves.

o For each instrument, a final curve is built that optimizes the available information from all of

the above sources.

Pricing Factors

Yield, program type, credit tier, collateral quality, counterparty risk, term, optionality, guarantor

credit risk.

Methodology


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9. Interest Rate Derivatives

Interest Rate Swaps, Inflation Swaps, Cross Currency Swaps and

Forward Rate Agreements

Description

An interest rate swap is an agreement under which two counterparties agree to a periodic

exchange of cashflows for a set length of time based on a specified notional amount of principal.

One of the cashflow streams typically is based on a fixed rate set at the inception of the contract,

and the other is referenced to an interest rate index that varies over time. At each payment date,

the two rates are compared, and the difference is paid by one counterparty to the other party.

PricingDirect evaluates interest rate swaps for below currencies and has the capability to add

more currencies upon request.

Because an interest rate swap is a contract between two parties, clients provide PricingDirect

with the relevant terms and conditions of the contract. If day count information is not provided,

PricingDirect will use the standard default day count conventions for each currency.

A zero coupon interest rate swap pays only one cashflow, at the maturity of the swap.

The notional principal amount for an amortizing interest rate swap declines over the life of the

swap, based on a predetermined schedule or benchmark.

The cashflows for a multi-leg interest rate swap are reported in discrete legs, rather than being

netted together, but are financially identical to a standard interest rate swap.

A cross-currency swap is an agreement between two parties to exchange principal and fixed or

floating rate interest payments on a loan in one currency, for principal and floating or fixed rate

interest payments on an equal loan in another currency.

A single currency basis swap is an agreement between two parties to exchange principal and

interest rate payments based on a float index, for principal and interest rate payments on a

different tenor index in the same currency, plus a spread.

A forward rate agreement is a cash settled forward contract that pays only one cashflow on the

settlement date of the contract. The cashflow is based on the present value of the difference

between the contract’s rate and the reference rate determined on the fixing date, times the

notional of the contract.

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An inflation swap is a variant of an interest rate swap, in which the floating payment is based

upon a specified inflation index rather than upon a specified interest rate. PricingDirect provides

evaluations for the following types of inflation swaps:

USD, on the US Urban CPI index;

EUR, on the HICP (Eurozone CPI ex-tobacco), FCPI (France CPI ex-tobacco) , ITCPI (Italy

CPI ex-tobacco), GRCP (Germany CPI) and SPCP (Spanish CPI) indices;

GBP, on the UK RPI index; and

JPY, on the Japan Nationwide CPI index.

AUD, on the AUD CPI index

Inputs


determine rates of various currencies based on actual traded prices, and through contacts

with the broker-dealer community.

PricingDirect evaluators capture real-time, intra-day snapshots of the interest rate, currency

basis and inflation curves provided by the J.P. Morgan trading desk. The interest rate curves

are built using the most actively traded securities for a given maturity, including cash and

money market instruments, futures and swap rates. In addition to access to real-time curve

snapshots, all of PricingDirect’s interest rate, currency basis and inflation curves undergo an

extensive quality control process before they are utilized for valuation. Our evaluators track

market data and news throughout the trading day to ensure that our rates are properly

capturing current market conditions.

For each snapshot throughout the day, our curves are compared to various market sources,

and tight tolerance levels are maintained to ensure a high level of quality. Once the curves

have been approved by the evaluators, another level of quality control is implemented on the

final output. Our evaluators check each individual derivative’s day-to-day price changes, to

confirm that all price deltas are consistent with the market’s movement. This process

improves the quality and independence of PricingDirect’s derivative evaluations.

Methodology


These models (1) build swap curves from the snapshots provided by the J.P. Morgan trading

desk, and (2) use those swap curves, along with other reference data, to derive valuations for

interest rate swaps, cross currency swaps, inflation swaps and forward rate agreements.

PricingDirect can evaluate interest rate swaps, inflation swaps and forward rate agreements by

discounting them to LIBOR, or by discounting them to OIS. In the case of discounting to OIS,

the J.P. Morgan trading desk marks the OIS basis to LIBOR across the term structure. OIS

rates are then generated using approximate conversion formulae to account for convention

adjustments. As a result, nominal observable data points (i.e. par coupon) will be the same

across the OIS and LIBOR curves. For valuation purposes, both projection curves and discount

curves incorporate the OIS basis, and the two curves may not necessarily be the same.

Unless instructed otherwise by our clients, the OIS methodology used by PricingDirect assumes

that the collateral to be posted will be in the same currency as the swap to be evaluated (except

for MXN, COP and BRL, as shown in the table below). OIS evaluations for major currencies will

be as follows:

Swap Currency Projection Curve OIS Discount Curve Assumed Collateral Posted

USD LIBOR Fed Funds USD

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EUR Euro LIBOR EONIA EUR

GBP Sterling LIBOR SONIA GBP

JPY Yen LIBOR TONA JPY

CAD CDOR CORRA CAD

AUD AUD-BBA AONIA AUD

NZD NZD-BB90D NZIONA NZD

SEK STIBOR SIOR SEK

MXN MXN-TIIE USD USD

COP IBR Onshore USD USD

BRL* CDI Offshore USD USD

*Using NDF methodology

Depending on clients’ specific CSA agreements, PricingDirect can also evaluate interest rate

swaps with the following discounting methodology:

Discounting curve in a different currency, which assumes the collateral will be posted

in a currency other than the swap currency; or

Cheapest to deliver (CTD), which assumes that the collateral can be posted in

multiple currencies.

The above discounting methods are available for selected currency pairings or combinations.

The CTD valuation model is developed by JP Morgan quantitative research and builds a

multi-currency cheapest to deliver curve. The CTD curve is based on the forward overnight

rates for each of the eligible single currencies, inclusive of an optionality component. As the

counterparty paying the collateral has the choice of selecting the collateral currency

throughout the life of the contract, the embedded optionality is valued based on a stochastic

model that takes into account the volatility of forward overnight rates.

PricingDirect can also evaluate non-deliverable interest rate swaps. Under the non-deliverable

methodology, the cashflows are forecasted using the non-deliverable curve (either onshore or

offshore) and then converted into deliverable currency cashflows by using NDF FX rates.

These cashflows are then discounted back to a present value using the deliverable currency

discounting curve. Depending on the deliverable/non-deliverable currency pair, PricingDirect

can use either Libor or OIS discounting.

PricingDirect offers non-deliverable interest rate swap evaluations on the below currencies

and has the capability to add more currencies upon request.

Swap Currency Projection Curve Discount Curve

BRL CDI Offshore USD

CNY CNRR007 Offshore USD

INR OIS Offshore USD

KRW KWCDC USD

MYR KLIBOR Offshore USD

THB THFX6M Offshore USD

TWD TAIBOR Offshore USD



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Interest Rate Swaptions, Caps, Floors and Collars

Forward Starting Interest Rate Swaptions

Inflation Caps, Floors and Collars

Description

The buyer of an interest rate swaption has an option to enter into an interest rate swap

contract on a specified date in the future.

The buyer of an interest rate cap receives money at the end of each period in which the

reference interest rate exceeds the agreed strike rate.

The buyer of an interest rate floor receives money at the end of each period in which the

reference interest rate is below the agreed strike rate.

An investor enters into an interest rate collar by simultaneously buying (selling) an interest

rate cap and selling (buying) an interest rate floor, each of which has an identical index,

maturity and notional principal amount.

PricingDirect evaluates swaptions, caps and floors for the following currencies: USD, EUR,

GBP, JPY and AUD, and has the capability to add more currencies upon request.

A forward starting interest rate swaption is a variant of an interest rate swaption in which

there is a lag between the swaption’s expiration date and the start date of the underlying swap.

PricingDirect provides valuations for USD forward starting interest rate swaptions.

An inflation cap, floor or collar is a variant of an interest rate cap, floor or collar, in which

the floating payment of the underlying contract is based upon a specific inflation index rather

than upon a specified interest rate. PricingDirect provides evaluations for the following types

of inflations caps, floors or collars:

USD, on the US Urban CPI index;

EUR, on the HICP (Eurozone CPI ex-tobacco), FCPI (France CPI ex-tobacco) , ITCPI (Italy

CPI ex-tobacco), GRCP (Germany CPI) and SPCP (Spanish CPI) indices; and

GBP, on the UK RPI index

JPY, on the Japan Nationwide CPI index.

Inputs

The J.P. Morgan trading desk and other market participants have access to the market

to determine rates and volatilities of various currencies based on actual traded prices, and


PricingDirect evaluators capture real-time, intra-day snapshots of the interest rate curves

and volatilities provided by the J.P. Morgan trading desk. Additionally, in the case of

forward starting interest rate swaptions, PricingDirect evaluators capture the correlation of

the underlying swap pairs provided by the J.P. Morgan trading desk. The interest rate

curves are built using the most actively traded securities for a given maturity, including

cash and money market instruments, futures and swap rates. In addition to access to real-

time curve snapshots, all of PricingDirect’s interest rate and inflation curves undergo an

extensive quality control process before they are utilized for valuation. Our evaluators

track market data and news throughout the trading day to ensure that our rates are

properly capturing current market conditions.



have been approved by the evaluators, another level of quality control is implemented on

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the final output. Our evaluators check each individual derivative’s day-to-day price

changes, to confirm that price movement is consistent with change in underlier’s rate and

with change in volatility.

Methodology



desk, and (2) build the volatility cube, which represents different volatilities for skews (in-the-

money, at-the-money, and out-of-the-money) based on expiration, underlier’s maturity and

strike. As the valuation tool, PricingDirect evaluators run a SABR model developed by J.P.

Morgan research that uses these curves and volatilities to derive evaluations for interest rate

swaptions, caps and floors.

PricingDirect can evaluate interest rate swaptions, caps and floors by discounting them to

LIBOR, or by discounting them to OIS. In the case of discounting to OIS, the J.P. Morgan

trading desk marks the OIS basis to LIBOR across the term structure. OIS rates are then

generated using approximate conversion formulae to account for convention adjustments. As

a result, nominal observable data points (i.e. par coupon) will be the same across the OIS and

LIBOR curves. For valuation purposes, both projection curves and discount curves

incorporate the OIS basis, and the two curves may not necessarily be the same. Unless

instructed otherwise by our clients, the OIS methodology used by PricingDirect assumes that

the collateral to be posted will be in the same currency as the swap to be evaluated.

OIS evaluations will be as follows:

Swap Currency Projection Curve OIS Discount Curve Assumed Collateral Posted

USD LIBOR Fed Funds USD

EUR Euro LIBOR EONIA EUR

GBP Sterling LIBOR SONIA GBP

JPY Yen LIBOR TONA JPY

AUD AUD-BBA AONIA AUD

Depending on clients’ specific CSA agreements, PricingDirect can also evaluate interest rate

swaptions, caps and floors with the following discounting methodology:

Cheapest to deliver, which assumes that the collateral can be posted in multiple

currencies; or


in a currency other than the swap currency.

The above discounting methods are available for selected currency combinations or pairings.

PricingDirect evaluators use the income approach, which discounts future cashflows to the

net present value of the derivative, as the valuation technique.

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Hybrid Structures

Description

A cancellable swap is a variant of an interest rate swap, in which one of the parties has the

option to terminate the swap on one or more predetermined dates prior to the swap’s

maturity.

PricingDirect provides evaluations for USD cancellable swaps and has the capability to add

other currencies upon request.

A limited price inflation (LPI) swap is a variant of an inflation swap, in which the floating

payment is capped and/or floored at pre-determined reference inflation rate levels that are

agreed upon at the inception of the swap.

PricingDirect provides evaluations for LPI swaps that are based on the UK RPI index.

Inputs


to determine rates and volatilities of various currencies based on actual traded prices, and


PricingDirect evaluators capture real-time, intra-day snapshots of the interest rate curves,

inflation curves and volatilities provided by the J.P. Morgan trading desk. These curves are

built using the most actively traded securities for a given maturity, including cash and

money market instruments, Eurodollar futures and swap rates. In addition to access to

real-time curve snapshots, all of PricingDirect’s swap curves undergo an extensive quality

control process before they are utilized for valuation. Our evaluators track market data and

news throughout the trading day to ensure that our rates are properly capturing current

market conditions.



have been approved by the evaluators, another level of quality control is implemented on

the final output. Our evaluators check each individual derivative’s day-to-day price

changes, to confirm that price movement is consistent with change in underlier’s rate and

with change in volatility.

Methodology



desk, and (2) build the volatility cube, which represents different volatilities for skews (in-the-

money, at-the-money, and out-of-the-money) based on expiration, underlier’s maturity and

strike. For deriving evaluations on the option component of these instruments, PricingDirect

evaluators run a SABR model developed by J.P. Morgan research that uses swap curves and

volatilities.

PricingDirect can evaluate cancellable swaps and limited price inflation swaps by discounting

them to LIBOR, or by discounting them to OIS. In the case of discounting to OIS, the J.P.

Morgan trading desk marks the OIS basis to LIBOR across the term structure. OIS rates are

then generated using approximate conversion formulae to account for convention adjustments.

As a result, nominal observable data points (i.e. par coupon) will be the same across the OIS

and LIBOR curves. For valuation purposes, both projection curves and discount curves

incorporate the OIS basis, and the two curves may not necessarily be the same. Unless

instructed otherwise by our clients, the OIS methodology used by PricingDirect assumes that

the collateral to be posted will be in the same currency as the swap to be evaluated.

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OIS evaluations for hybrid instruments will be as follows:

Instrument Projection Curve OIS Discount Curve Assumed Collateral Posted

USD Cancellable Swap LIBOR Fed Funds USD

UK LPI UK RPI Inflation SONIA GBP

Depending on clients’ specific CSA agreements, PricingDirect can also evaluate cancellable

swaps with the following discounting methodology:

Cheapest to deliver, which assumes that the collateral can be posted in multiple

currencies; or


in a currency other than the swap currency.

The above discounting methods are available for selected currency combinations or pairings.



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10. Credit Derivatives

Credit Default Swaps (Single Name CDS)

Description

A credit default swap (CDS) is used to transfer the credit risk of an underlying entity—called

the “reference entity”—from one party to another. It is a bilateral contract between two parties,

one of which is the protection buyer and the other of which is the protection seller. The

protection buyer pays a fixed coupon to the protection seller at a predetermined frequency, for

a specified notional amount of protection.

In case of a default event, the protection seller pays the protection buyer the notional amount

of the protection (par), while the protection buyer delivers debt obligations of the reference

entity to the protection seller. In practice, most contracts are settled in cash, and the amounts

exchanged are netted. Since defaulted debt by definition trades below par, the difference

between par and the value of the reference obligation implicitly defines the “recovery rate”, or

the percent of par at which the bonds are valued after default.

The client provides PricingDirect with the following terms and conditions of the CDS contract:

Credit name Reference obligation Currency

Coupon Start date Maturity date

Buyer/Seller Restructuring type Seniority

There are several additional fields such as day count, pay frequency, ISDA definition clause

and notional amount, that can either be provided by the client, or for which PricingDirect will

use default values.

Inputs


to determine spreads of various credit names based on actual traded prices, and through


PricingDirect evaluators capture real-time updates from the J.P. Morgan trading desk on

credit spreads and curves for issuers throughout the day via emails and database. The

evaluators maintain credit curves and recovery rates for these issuers, which may vary

depending on the restructuring convention and the position in the capital structure. The

curves are monitored throughout the day to adjust for changes in the market. The

evaluators also actively monitor other sources of macroeconomic news on their respective

sectors throughout the day. In addition, the evaluators may calculate additional inputs

based on actual data, spread information from the trading desk and market assumptions.

Pricing Factors

Credit spreads, recovery rates, interest rate curves.

Methodology

PricingDirect evaluators use a CDS evaluation model that is developed and supported by the

J.P. Morgan quantitative research team. Conditional default probabilities are modeled as a

continuous curve from observable market spreads.

The issuer credit curve, which is the major factor in an evaluation, is dependent on market

quotes. For issuers with multiple debt structures,restructuring types, settlement currencies

and/or ISDA definition clauses, PricingDirect maintains multiple credit curves and assigns an

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appropriate curve to each swap. In addition, PricingDirect evaluators monitor the market

throughout the day to capture issuer-specific changes, which are incorporated in the

evaluations. The traders assign recovery rates to each issuer according to the current credit

standing of the entity in the marketplace.

The CDS evaluation model determines default probabilities from the issuer credit curves.

Both default probabilities and recovery rates are used to evaluate each swap, and cash

settlement is assumed. The CDS evaluation model determines the appropriate cashflows for

both legs of the swap (based on default probability and recovery rate for the contingent leg,

and based on survival probability for the premium leg).



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Credit Default Swap Indices (CDSI)

Description

A credit default swap index (CDSI) is a standard portfolio of weighted single name credit

default swaps. It provides default protection on each single name contract in the underlying

portfolio. The protection buyer makes fixed quarterly payments to the protection seller for the

duration of the contract or until all the constituents of the index are subject to a credit event.

The names that are part of the index are usually equally weighted. The most common and

liquid maturities are five, three, seven and ten years. A new “on-the-run” index is launched

every six months; the new index tends to be the most liquid, but older indices continue to

trade as “off-the-run”. Once an index is created, its content remains static over time, except

for removals due to credit events.

PricingDirect supports evaluation of CDS indices for US, Europe and Asia in investment grade,

high volatility, high yield, crossover, loan CDS, muni CDS and emerging markets.

The client provides PricingDirect with the following terms and conditions of the CDS index

contract:

Index name Reference Code Currency


Buyer/Seller

There are several additional default fields used by PricingDirect such as day count, pay

frequency and notional amount.

Inputs


to determine credit index spreads based on actual traded prices, and through contacts with

the broker-dealer community.


both on-the-run and off-the-run index curves throughout the day via emails and database.

The evaluators maintain credit curves for the indices according to their standard maturity

and recovery rates. The curves are monitored throughout the day to adjust for changes in

the market. The evaluators also actively monitor other sources of macroeconomic news

throughout the day, as well as specific news concerning credit names that are part of each

index. In addition, the evaluators may calculate additional inputs based on actual data,

spread information from the trading desk and/or market assumptions.

Pricing Factors

Credit index spreads, recovery rates, interest rate curves

Methodology

The PricingDirect evaluation process for credit default swap indices is very similar to that of

single-name credit default swaps, except that there is an independent market for each product

(CDS and CDSI).

PricingDirect evaluators use a CDS evaluation model that is developed and supported by the

J.P. Morgan quantitative research team. Conditional default probabilities are modeled as a

continuous curve from observable market spreads.

The CDS model determines default probabilities from the index-specific credit curves. Both

default probabilities and recovery rates are used to evaluate the swap, and cash settlement is

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assumed. The evaluation model determines the appropriate cashflows for both legs of the

swap (based on default probability and recovery rate for the contingent leg, and based on

survival probability for the premium leg).



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Credit Default Swap Index Tranches (CDSI Tranches)

Description

A standard synthetic CDSI tranche is a bilateral, over-the-counter credit derivative contract

that transfers a portion of the credit risk of an index (a portfolio of single-name credit default

swaps) from the protection buyer to the protection seller. The protection buyer pays the seller

a periodic premium in return for credit protection. The premium payments as well as the credit

protection continue until the transaction matures or until the notional amount of the tranche is

fully written down by losses.

Standard tranches mature on the maturity date of the underlying index. The contract specifies

a range of credit losses in the portfolio referenced by the tranche and risk transference is

limited to losses in a specified band. The band is defined by the attachment and detachment

points. These points represent the losses as a percentage of the reference portfolio notional

amount.

PricingDirect supports evaluation of CDSI tranches for CDX IG, CDX HY, LCDX, iTraxx Main

and iTraxx Crossover,

The client provides PricingDirect with the following terms and conditions of the CDSI tranche

contract:



Buyer/Seller Attachment Point Dettachment Point

There are several additional default fields used by PricingDirect such as day count, pay

frequency and notional amount.

Inputs


to determine spreads on underlying credit names based on actual traded prices, and



credit spreads and both on-the-run and off-the-run index curves throughout the day via

emails and database. The evaluators maintain credit curves for the indices and underlying

single names according to their standard maturity and recovery rates. The curves are

monitored throughout the day to adjust for changes in the market. The evaluators also

actively monitor other sources of macroeconomic news throughout the day, as well as

specific news concerning credit names that are part of each index. In addition, the

evaluators may calculate additional inputs based on actual data, spread information from

the trading desk and/or market assumptions.

Pricing Factors

Single name spreads, recovery rates, tranche base correlations, interest rate curves

Methodology

PricingDirect evaluators use a base correlation model that is developed and supported by the

J.P. Morgan quantitative research team.

Base correlations are derived from market spreads through a bootstrapping process using a

stochastic recovery Copula model. Base correlations, spreads and recovery rates of

underlying credit names are then used to evaluate the swap.

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Credit Default Swap Index Options (CDSI Options)

Description

A credit default swap index option is an option to buy or sell CDS protection on a specified

reference entity at a fixed spread/price (the strike) on a specified future date. A call option

gives the holder the right, but not the obligation, to enter into a long risk CDS contact (receive

strike spread/price). A put option gives the holder the right, but not the obligation, to enter into

a short risk CDS contact (pay strike spread/price).

Index options do not “knock-out” if there is a credit event on an underlying name. In this case,

the contract remains on the original series that includes the name that experienced a credit

event. At expiration, the option buyer will exercise the option on the “old” index (with the

defaulted name), the defaulted name will be triggered by the buyer of protection, and the

index will then become the current index after the defaulted name is removed.

PricingDirect evaluates CDSI options with a European-style expiry on both on-the-run and off-

the-run CDX and iTraxx indices.

The client provides PricingDirect with the following terms and conditions of the CDSI option

contract:


Index Start date Index Maturity date Option Expiry

Strike Option Type (Put/Call) Long/Short Option

There are several additional default fields used by PricingDirect such as index coupon, pay

frequency, day count convention and notional amount.

Inputs


to determine spreads and volatilities of various indices based on actual traded prices, and



index spreads and volatilities throughout the day via emails or database. For each index,

the evaluators maintain spread curve and volatility matrix based on standard expiry dates

and strikes. The spreads and volatility matrices are monitored throughout the day to adjust

for changes in the market. The evaluators also actively monitor throughout the day other

sources of macroeconomic news, as well as specific news concerning credit names that

are part of the index.

Pricing Factors

Credit index spreads, volatility matrix, interest rate curves

Methodology

PricingDirect evaluators use a valuation model that is developed and supported by JP

Morgan’s quantitative research team. The model used is a Black-76 model that relies on

lognormal distribution of spreads at maturity. The forward CDS spread is adjusted upward to

account for the no knock-out feature, since an index option offers protection from the day of

the trade as opposed to the forward that only offers protection from the option expiry.

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Bond Forwards

Description

The bond forward is the contract between two parties at a given price and on a given date.

The client provides a date in the future and a strike price.

Methodology

PricingDirect evaluators uses a valuation model to calculate forward price based upon spot

price as described in the methodology book in various sections and financing rate.

Bond Total return Swaps

Description

The total return swaps are a derivative instrument in which without owning the underlying

bond you get the exposure underlying return of the bond.

Methodology

The total return swap is calculated based upon starting price(strike). PricingDirect can provide

evaluations based upon one or two legs. One leg would provide capital gain and accrued

interest and other leg would provide financing cost.

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11. Mortgage Synthetic

IOS/POS/MBX Total Return Swaps

Description A total return swap (TRS) allows the party holding the swap to receive any income generated, in the form of interest payments and potential asset appreciation, by the underlying asset. The TRS underlying asset in this case are either an Interest-Only Synthetic (IOS), Principal-Only Synthetic (POS) or Mortgage-Backed Synthetic (MBX) indices.

Inputs

The J.P. Morgan trading desk has access to the market to determine spreads/prices on

the indices based on actual traded prices.

Markit provides access to the (i) reset index prices based on the closing prices submitted

from their dealer contributors, and (ii) reset index factors.

Pricing Factors

Current Index Price

o This is the underlying asset price obtained each valuation day from a 3pm EST

snapshot provided by the J.P. Morgan trading desk.

Reset Index Factor

o This is the underlying asset factor one NY business day prior to the 12th of each month.

Reset Index Price

o This is the underlying asset final closing price one NY business day prior to the 12th of

each month.

Reset 1 Month LIBOR Rate

o This is the 1M LIBOR rate one NY business day prior to the 12th of each month.

Index Coupon

o This is the net coupon of the underlying asset.

Original Trade Notional

o This is the original face trade size of the swap. In the absence of any original face trade

size provided by the client, PricingDirect will use $1 million.

Methodology

PricingDirect IOS, POS and MBX TRS valuations are a difference between the Reset Index Price and Current Index Price plus the addition of an interest and financing component for a given valuation time horizon.

The interest component is the fixed interest amount calculated from the Reset Date to the date on which PricingDirect provides the related valuation (Index Coupon x Original Trade Notional x Reset Index Factor) which the TRS buyer receives from the TRS seller. The financing component is calculated for the period between the Reset Date and the date on which PricingDirect provides the related valuation (Reset 1 Month LIBOR Rate x Reset Index Price x Original Trade Notional x Reset Index Factor), which the TRS buyer pays to the TRS seller. The “Reset Date” means the date that occurs one NY business day prior to the 12

th of each month.

The new accrual period will begin on the 12th of each month. The Reset Index Price for the new

accrual period will use the closing price provided by Markit on the Reset Date. PricingDirect calculates the TRS valuation on a daily basis based on the pricing components as described above.

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12. Foreign Exchange Derivatives

Forwards, Non-Deliverable Forwards, Average Rate Forwards,

Double Average Rate Forwards, Average Strike Forwards,

Vanilla Options, Asian Options, Digital Options, Barrier Options,

Basket Options, Basket Average Options, Touch Options,

Average Strike Options, Double Average Options, Swaps,

Variance Swaps, Volatility Swaps

Description

An FX forward is an agreement to purchase or sell a set amount of a foreign currency at a

specified price for settlement at a predetermined future date. The two parties will physically

exchange the currencies on the settlement date. In an FX non-deliverable forward, netting of

profit/loss on the contract rather than physical exchange will occur on the settlement date.

An FX average rate forward is a forward whose payoff is determined by the average value of

the spot rates of an underlying asset on a specific set of dates prior to maturity.

An FX double average rate forward is an average rate forward whose strike is set equal to the

average value of the underlying asset on a specific set of dates prior to the payout date.

An FX average strike forward is a forward whose strike is set equal to the average value of the

underlying asset on a specific set of dates prior to the payout date.

An FX vanilla option is a derivative financial instrument that grants the owner the right but not

the obligation to exchange money denominated in one currency into another currency, at a

predetermined exchange rate on a specified date.

An FX Asian option is an option whose payoff depends on the average value of the spot rates

of an underlying asset over a specified period.

An FX digital option is a type of exotic option whose payoff is either a specified amount or

nothing at all, depending on whether the underlying asset exceeds a predetermined threshold.

An FX barrier option is a type of exotic option whose payoff depends on whether the underlying

asset reaches or exceeds a predetermined price; there can be a single barrier or a double

barrier.

An FX basket option is a type of exotic option whose underlying asset is a weighted sum of

different assets.

An FX basket average option is a type of exotic option whose payoff depends on the average

of the underlying basket.

An FX no-touch, one-touch or double-touch option is a type of digital option whose payoff

depends on whether the price of the underlying asset reaches, or does not reach, one or two of

the predetermined barrier levels.

An FX average strike option is an option whose strike is set equal to the average value of the

underlying asset on a specific set of days prior to the payout date.

An FX double average option is an Asian option whose strike is set equal to the average value

of the underlying asset on a specific set of dates prior to the payout date.

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An FX swap is a simultaneous purchase and sale of identical amounts of one currency for

another with two different value dates (normally spot to forward).

An FX variance swap is a type of volatility swap for which the payout is linear to variance rather

than volatility.

An FX volatility swap is a forward contract on the future realized volatility of a given underlying

asset.

PricingDirect provides extensive coverage of the above options, swaps and forwards in a large

number of major and minor currencies, including the core currencies and others from Europe,

the Middle East, Africa, Latin America and Asia.

Inputs


determine yields of various currencies, the FX spot and forward curves, FX volatilities, and

interest rates based on actual traded prices, and through contacts with the broker-dealer

community.

PricingDirect evaluators capture real-time, intra-day snapshots of the interest rate curves,

FX spot, forward curves provided by the J.P. Morgan trading desk. The interest rate curves

are built using the most actively traded securities for a given maturity, including cash and

money market instruments, futures and swap rates. In addition to access to real-time curve

snapshots, all of PricingDirect’s interest rate and forward curves and volatility surfaces

undergo an extensive quality control process before they are utilized for valuation. Our

evaluators track market data and news throughout the trading day to ensure that our rates

properly capture current market conditions.



have been approved by the evaluators, another level of quality control is implemented on the

final output. Our evaluators check each individual derivative’s day-to-day price changes, to

confirm that all price deltas are consistent with the market’s movement.

Methodology

The J.P. Morgan FX derivatives quantitative research (QR) group has developed a set of models for pricing vanilla and exotic products. For European vanilla FX options, PricingDirect uses the Garman Kohlhagen pricing model, which is mathematically identical to the variation of Black Scholes for options on a dividend-paying stock (Black-Scholes-Merton), only the stock’s continuous dividend yield now represents the foreign currency’s continuously compounded risk-free rate. Many exotic FX options (such as single and double barrier options, one touch, no touch, double one touch and double no touch options) are priced using a stochastic local volatility model with a stochastic interest rate adjustment. The stochastic interest rate adjustment is calculated by modeling the two interest rates using a Hull-White model. This allows the model to separate FX spot volatility and interest rate volatility (as opposed to modeling forward volatility alone). At expiration barrier options are priced through a technique known as vanilla replication, i.e. as a portfolio of vanilla options.

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13. Equity Derivatives

Vanilla Options, Asian Options, Barrier Options,

Variance Swaps, Callable Total Return Swaps

Description

An equity vanilla option is a derivative financial instrument that grants the owner the right but

not the obligation to purchase (call) or sell (put) an equity instrument (single name or index), at a

predetermined strike on or before a specified date.

An equity Asian option is an option whose payoff depends on the average value of an

underlying equity over a specified period.

An equity barrier option is a type of exotic option whose payoff depends on whether the

underlying asset reaches or exceeds a predetermined price.

An equity variance swap is a derivative financial instrument whose payoff depends on the

difference between the realized variance of the returns on the underlying asset and the strike.

All of the above instruments can be priced on a single name or an index underlying.

An equity total return swap is a derivative financial instrument in which one party makes regular

payments based on a set rate or index, while the other party makes payments that are based on

the performance of an underlying asset.

Inputs


determine equity spot and forward prices, equity volatilities and interest rates.

Methodology

The J.P. Morgan equity derivatives quantitative research (QR) group has developed a set of

models for pricing vanilla and exotic products. For pricing European index equity vanilla options,

PricingDirect uses the variation of the Black-Scholes formula that was devised for a dividend-

paying stock. The model uses continuous dividend yield, which is reflected in the forward price of

the underlying instrument. For pricing American options, the tree model is used with discrete

dividends.

The pricing of equity total return swaps entails pricing both the asset and the financing legs. The

model calculates the total return of the equity leg up to the valuation date and the accrued

interest for the funding leg.

A closed form Black-Scholes model is used for pricing Asian options, while a finite difference

model with local volatility is used for barrier options. PricingDirect equity derivatives evaluators

use the same proprietary models and equity data that are employed by the J.P. Morgan equity

derivatives trading desk.

The variance swap is priced using ClosedFormIntegrateLN model. The model decomposes the

payoff of the variance swap into a weighted sum of calls and puts which are priced using Black-

Scholes model mentioned above.

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14. Commodity Derivatives

Vanilla Options, Asian Options, Basket Options,

Basket Average Options, Forwards, Swaps, Basis Swaps,

Spread Swaps, Callable Total Return Swaps

Description

A commodity vanilla option is a derivative financial instrument that grants the owner the right

but not the obligation to purchase (call) or sell (put) an underlying commodity at a predetermined

strike on a specified date.

A commodity Asian option is an option whose payoff depends on the average value of an

underlying commodity over a specified period.

A commodity basket option is a type of exotic option whose underlying asset is a weighted sum

or average of different commodities.

A commodity basket average option is a type of basket option for which the underlying

commodities are averaged over a specified set of fixing dates.

A commodity forward is an agreement to purchase (call) or sell (put) a set amount of a

commodity at a specific price for settlement at a predetermined future date.

A commodity swap is an agreement between two parties whereby a floating (or market or spot)

price based on an underlying commodity is exchanged for a fixed price over a specified period.

The floating price is the average price of the underlying commodity over a series of

predetermined fixings, whereas the fixed price is determined at the inception of the trade. The

swap may have a single settlement date or a series of settlement dates.

A commodity basis swap is an agreement between two parties whereby the first party pays the

second party the price of a commodity, and the second party pays the first party the price of a

different commodity, plus a spread.

A commodity spread swap is an agreement between two parties whereby a floating (or market

or spot) price based on the difference between the prices of two underlying commodities is

exchanged for a fixed price over a specified period.

A commodity variance swap is a derivative financial instrument whose payoff depends on the

difference between the realized variance of the returns on the underlying asset and the strike.

A commodity total return swap is a derivative financial instrument in which one party makes

regular payments based on a set rate or index, while the other party makes payments that are

based on the performance of an underlying asset.

Inputs


determine commodity spot and forward prices, commodity volatilities and interest rates.

Methodology

The J.P. Morgan commodities quantitative research (QR) group has developed a set of models

for pricing exchange listed and OTC commodity options. PricingDirect provides evaluations on

commodity derivatives for which the underlying is either energy (various oil benchmarks as well

as non-oil commodities), base metals, precious metals or an index. PricingDirect commodity

derivative evaluators use the same proprietary models and market data that are employed by the

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J.P. Morgan commodities trading desk. For commodity options, PricingDirect uses the Black-76

model, in which the spot price of the underlying is replaced by the futures price.

At each valuation snapshot, a swap’s forward price is marked by traders either from a market

quote or from the trader’s estimate. The trader’s estimate may be based upon, but not limited to,

one or more of the following: a mark that is flat to a previous trade, a spread to a benchmark, a

linear combination of benchmarks, and/or adjustments based upon seasonal or annual spreads.

The swap’s fixing is obtained from the appropriate publication source for each commodity.

For commodity variance swap, the model supports both fixed underlying futures contract and

rolling underlying futures contract. Fixed contract variance swap is priced using vanilla

replication. Floating prompt variance swap is priced using N-factor mean reverting model.

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15. ASC Topic 820

FASB ASC Topic 820 (formerly FAS 157) is a statement by the Financial Accounting Standards

Board (“FASB”) that defines fair value, establishes a framework for measuring fair value in

GAAP, and specifies the requirements for disclosures about fair value measurements. This

statement was developed by FASB in order to increase consistency and comparability in fair

value measurements, and is effective for financial statements issued for fiscal years beginning

after November 15, 2007 and their interim periods.1 PricingDirect has prepared this Evaluation

Methodology booklet in order to assist clients in determining and disclosing the requisite fair

value measurements.

PricingDirect has developed a methodology that relies on information from J.P. Morgan trading

desks and research, other market participants including our clients, electronic trading platforms

such as TRACE, and/or third-party data vendors to provide market intelligence. In order to

create a reliable, systematic and scalable process, PricingDirect has classified the instruments it

evaluates into over 40 broad asset classes, and over 500 more detailed sub-sectors. Within

each of these asset classes, we have developed methodologies that allow us to utilize available

market information to evaluate the full universe of securities. Though the details of the

evaluation methodology may be different for each asset class, PricingDirect’s generic evaluation

methodology includes the following steps:

Trader Input: For all asset classes, PricingDirect receives information about traded

securities and evaluations of benchmark securities directly from the J.P. Morgan trading

desks. For most asset classes, PricingDirect also receives information from other market

participants including our clients, electronic trading platforms such as TRACE, and/or third-

party data vendors. The J.P. Morgan trading desks are direct market participants who trade

in their asset class every business day and commit capital to support markets. PricingDirect

treats their evaluations as the market level, and does not describe how the traders determine

their evaluations since they are the market makers. The traders may use models while

trading.

Traders provide PricingDirect with evaluations for actively traded securities, i.e., those

securities that are very liquid such as government securities, TBA mortgages, certain agency

CMOs, and benchmark securities in other asset classes, including securities whose issuers

are in the news. All such evaluations of actively traded securities contain information and

intelligence that can be used to evaluate less actively traded securities. The information that

PricingDirect receives from other sources may be used to supplement the information

obtained from the J.P. Morgan trading desks, or to perform quality control procedures on that

information, or for a combination of both.

Quality Control on Trader Input: The trader input is treated as sample input from market

participants. PricingDirect evaluators may perform quality control tests on prices obtained

from the trading desk and/or other sources, using established principles and procedures.

Some sample evaluations are not used in the methodology development, but are used

instead for out-of-sample testing. As a result of these quality control procedures, evaluators

may adjust the prices that PricingDirect receives from its sources for certain securities.

Calculated Input: J.P. Morgan research has developed state-of-the-art analytical models

and statistical techniques, which may be used to determine the underlying evaluation factors

(e.g., spreads, credit curves, forward curves, prepayment speeds). For example,

PricingDirect evaluators may use mortgage prepayment and default models to determine

projected prepayment speeds and default rates for mortgage-backed securities.

Rules Based Adjustments: The securities in each asset class are grouped by security

characteristics and/or performance. PricingDirect evaluators, in conjunction with the trading

1 Please note that PricingDirect does not provide advice regarding FASB ASC Topic 820 or any other accounting, regulatory or legal

advice.

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desk, develop rules based logic to evaluate such groups of securities. Starting with the bonds

evaluated by traders, they may adjust the pricing factors so that they can evaluate other

securities in the same asset class. This methodology uses market observable input from both

traders and evaluators based on historical data and current market conditions. These inputs

may reflect relative differences among evaluation factors or adjustments for specific

characteristics of securities within an asset class.

Evaluation Models: PricingDirect evaluates the remaining securities in each asset class

using the previously established evaluation factors and the NPV or OAS models developed by

J.P. Morgan research.

Out-of-Sample Testing: PricingDirect tests out-of-sample evaluations to ensure that the

evaluation methodology is optimal for all securities. This process is repetitive and dynamic,

and requires frequent analysis by PricingDirect’s evaluators to ensure that we deliver market-

based valuations.

Refinements: Current offerings, actual transactions and prior evaluations are monitored in

order to continually refine the evaluation methodology. As securities change over time, our

evaluation methodology may be adjusted to be consistent with current conditions. For

example, corporate bond evaluations reflect the impact of any ratings downgrades, while

evaluations of CMOs reflect the current cashflow profile of each tranche, so a “busted PAC”

would be evaluated as a sequential bond.

Quality Control on Output: Prior to each delivery, PricingDirect evaluators perform multiple

quality control procedures on final output, including tests for “stale” prices and validation of

day-to-day price changes. For derivative instruments, additional controls are performed on

volatility inputs, swap curves, currency exchange rates and other factors, including model

output such as DV01.

Mean Pricing: PricingDirect provides bid, mean and offer evaluations for fixed income

securities. For each fixed income asset class, PricingDirect has developed mean pricing

methodologies that account for the unique trading characteristics of that asset class.

Depending on the asset class, the methodology may incorporate dollar duration, spread

duration, average life, dollar price spread, or a combination of these and other factors. With

regards to our derivatives pricing, we provide a mid-market evaluation, which is market

convention.

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16. Summary: PricingDirect Product Coverage

GOVERNMENT AND SUPRANATIONAL SECURITIES

U.S. TREASURY SECURITIES U.S. GOVERNMENT AGENCY DEBENTURES AND SUPRANATIONALS U.S. GOVERNMENT AGENCY AND SUPRANATIONAL STRIPS

EUROPEAN SOVEREIGNS AND SUPRANATIONALS

MORTGAGE-BACKED SECURITIES

TO BE ANNOUNCED SECURITIES (TBAS) STIPULATED TO BE ANNOUNCED SECURITIES ( STIP TBAS) OPTIONS ON TO BE ANNOUNCED SECURITIES (TBA OPTIONS)

FIXED-RATE PASS-THROUGH CERTIFICATES (SPECIFIED POOLS) ADJUSTABLE-RATE MORTGAGE SECURITIES (ARMS) SMALL BUSINESS ADMINISTRATION POOLS (SBAS)

STRUCTURED AGENCY MORTGAGE IO/PO AGENCY MORTGAGE INVERSE IO COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS)

COMMERCIAL MORTGAGE-BACKED SECURITIES (CMBS) DELEGATED UNDERWRITING AND SERVICING POOLS (DUS)

GNMA PROJECT LOAN SECURITIES

HARD-TO-VALUE SECURITIES (HTV)

NON-AGENCY RMBS RESECURITIZATIONS PRIME JUMBO AND ALT-A FIXED / ARM AND PAYMENT OPTION ARM CMOS (SUBORDINATES)

SUBPRIME MORTGAGE-BACKED CMOS (SUBORDINATES) MANUFACTURED HOUSING

ASSET-BACKED SECURITIES

AUTOS CREDIT CARDS

STUDENT LOANS

COLLATERALIZED LOAN AND DEBT OBLIGATIONS

BROADLY SYNDICATED AND MIDDLE MARKET STRUCTURES (CLOS) SMALL AND MEDIUM ENTERPRISE STRUCTURES (SME CLOS)

CORPORATE SECURITIES

INVESTMENT GRADE CORPORATE BONDS

HIGH YIELD CORPORATE BONDS EMERGING MARKET BONDS

NON-US SECURITIES

EUROPEAN SOVEREIGNS AND SUPRANATIONALS EUROPEAN INVESTMENT GRADE, HIGH YIELD AND COVERED BONDS

EUROPEAN PRIME AND NON-PRIME MORTGAGE-BACKED SECURITIES (MBS) UK MBS (PRIME, NON-CONFORMING, BUY-TO-LET) AUSTRALIAN MBS

EUROPEAN CLOS AND SME CLOS UK AND EUROPEAN AUTO LOANS, STUDENT LOANS, CONSUMER LOANS AND CREDIT CARDS

MONEY MARKET INSTRUMENTS

CORPORATE AND ASSET-BACKED CP

REPURCHASE AGREEMENTS (RPS) CERTIFICATES OF DEPOSIT (CDS) BANKERS’ ACCEPTANCES (BAS)

INTEREST RATE DERIVATIVES INTEREST RATE SWAPS, INFLATION SWAPS AND FORWARD RATE AGREEMENTS

FORWARD STARTING INTEREST RATE SWAPTIONS INTEREST RATE SWAPTIONS, CAPS, FLOOR AND COLLARS INFLATION CAPS, FLOORS AND COLLARS

HYBRID STRUCTURES

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CREDIT DERIVATIVES CREDIT DEFAULT SWAPS (SINGLE NAME CDS)

CREDIT DEFAULT SWAP INDICES (CDSI) CREDIT DEFAULT SWAP INDEX TRANCHES (CDSI TRANCHES) CREDIT DEFAULT SWAP INDEX OPTIONS (CDSI OPTIONS)

CREDIT DEFAULT SWAPS ON ABS (ABS/CDS) CREDIT DEFAULT SWAPS ON ABS INDICES (ABS/CDS INDICES)

MORTGAGE SYNTHETIC

IOS/POS/MBX TOTAL RETURN SWAPS

FOREIGN EXCHANGE DERIVATIVES FORWARDS

NON-DELIVERABLE FORWARDS AVERAGE RATE FORWARDS DOUBLE AVERAGE RATE FORWARDS

AVERAGE STRIKE FORWARDS VANILLA OPTIONS ASIAN OPTIONS

DIGITAL OPTIONS BARRIER OPTIONS (SINGLE AND DOUBLE) BASKET OPTIONS

BASKET AVERAGE OPTIONS NO-TOUCH, ONE-TOUCH AND DOUBLE-TOUCH OPTIONS AVERAGE STRIKE OPTIONS

DOUBLE AVERAGE OPTIONS SWAPS VARIANCE SWAPS

VOLATILITY SWAPS CROSS-CURRENCY SWAPS

EQUITY DERIVATIVES

VANILLA OPTIONS ASIAN OPTIONS

BARRIER OPTIONS VARIANCE SWAPS CALLABLE TOTAL RETURN SWAPS

COMMODITY DERIVATIVES

VANILLA OPTIONS ASIAN OPTIONS BASKET OPTIONS

BASKET AVERAGE OPTIONS FORWARDS SWAPS

BASIS SWAPS SPREAD SWAPS CALLABLE TOTAL RETURN SWAPS

gy o - gy 5 1. introduction general principles of pricingdirect’s evaluation methodology...

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