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Other considerations

Comparative funding advantage application

Introduction

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What are Derivatives?

“a financial contract whose value is linked to, or derived from, that of an underlying asset such as a bond, stock, or commodity”

- Wall Street Journal

Available for...Available for... In a variety of forms...In a variety of forms...

Interest Rate

Currency

Commodity

Equity

Credit

Exchange-traded Listed futures and options

Over the counter, bilateral contracts Swaps, forwards, options, etc.

Securitized Callable bond, convertibles,

structured notes

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Derivatives allow the efficient interaction between issuers and investors in the capital markets

IssuersIssuers InvestorsInvestors

Capture comparative advantages across markets

Transparency in evaluating cost alternatives

Removes interest rate, currency and market preference from decision-making

Invest in instruments or credits not available in desired markets

Overcome liquidity restraints to specific markets allocation

Isolate or introduce interest rate and credit risk as desired

A financial wold without boundaries, where managers can define the risk of their asset/liability portfolio strictly according to economic conditions

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Issuer objectives

Raise long term money (10yrs)

Create liabilities in USD only (issuer is USD functional)

Achieve a spread with a low premium compared to both the Sovereign and same name in the international market

Create demand for its bonds by local investors

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IADB_seminarCorporate bonds tend to price tighter to the sovereign onshore vs. offshore

Synthetic USD bondSynthetic USD bond

Risk free rate (Treasury)

Sovereign Spread

Corp. Spread

4.00%

0.50%

0.70%

5.00%

0.50%

5.20% (T + 1.20%) 5.50% (Local T + 0.50%)

Yankee Bond

(USD)

Local Bond

(Pesos)

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IADB_seminarAlthough the local bond has a higher coupon, it’s priced at a lower spread to local Libor


Sovereign Spread

Corp. Spread 0.55%

USD Libor + 0.55% Local Libor + 0.10%

4.00% 5.00%

0.10%

0.65% 0.40%

Yankee Bond

(USD)

Local Bond

(Pesos)

Relative savings of 45bp, but it local currency terms...

Savings must be compared in USD equivalent terms...

Libor (Treasury + Swap Spread)

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Converting the spread over local Libor to a USD fixed equivalent yields a synthetic USD bond with a lower coupon


Libor (Treasury + Swap Spread)

Corp. Spread

USD Libor + 0.30%

4.00%

0.65%

Synthetic Yankee Bond

(USD)

Local Libor + 0.10%

5.00%

0.10%

0.40%

Local Bond

(Pesos)

Swap from pesos to

USD

0.10%

0.20%Basis/ Credit Charge

Savings of USD 25bp to Yankee bond

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Swap cashflows


Issuer JPMorgan

Local Investor

USD

Local Currency

Local Currency

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IADB_seminarThis comparative advantage presents itself opportunistically

Credit priced more aggressive to the sovereign in the local market

Local market swap market must be available and liquid Basis risk between bonds and swaps

Wide USD swap spreads and narrow local swap spreads

Limited credit availability to deal in swaps Credit pricing can erode this advantage

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IADB_seminarA synthetic USD bond can improve funding costs

Client swaps Local debt from

local currency to USD

Client swaps Local debt from

local currency to USD

All-in USD rate in Swap yields a synthetic USD

bond that is cheaper than

Yankee issuance

All-in USD rate in Swap yields a synthetic USD

bond that is cheaper than

Yankee issuance

Issue local Debt at spread of

100bp to benchmark

Issue local Debt at spread of

100bp to benchmark


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IADB_seminarWhen structuring a derivative transaction, it is important to consider the following issues

Credit How much credit exposure arises in a derivative transaction? How is the credit exposure handled? Depends on type of transaction (single vs. cross-currency)

Documentation Is the appropriate documentation on file? (ISDA, CSA, Trade

Confirmation, etc.) What are the specific terms that must be agreed to? Local legal implications

Acces to local markets Observable yield curve Liquidity considerations

* Credit and documentation affect the pricing of a derivative transaction

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IADB_seminarThe credit cost of a transaction can be reduced using a variety of techniques

Collateral agreementMark-to-market structure

Guarantee

Letter of credit

Special purpose vehicles

Elective termination right

Credit downgrade protection

Reduce exposure profile

Reduce default risk, spreads

Combination- reduce total cost

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This presentation was prepared exclusively for the benefit and internal use of IDB in order to indicate, on a preliminary basis, the feasibility of a possible transaction or transactions and does not carry any right of publication or disclosure to any other party. This presentation is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan.

The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all of which are subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of IDB or which was otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of IDB. The information in this presentation does not take into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other effects

JPMorgan is a marketing name for investment banking businesses of J.P. Morgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan arranging, financial advisory and other investment banking activities are performed by J.P. Morgan Securities Inc. and its securities affiliates, and lending, derivatives and other commercial banking activities are performed by JPMorgan Chase Bank and its banking affiliates. JPMorgan deal team members may be employees of any of the foregoing entities.

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