A G E N C Y C O L L A T E R A L I Z E D M O R T G A G E O B L I G A T I O N S

CMO Structuring and Trading: 212-834-4477

Sam Choi: Derivatives Trading

Adi Rabinowitz: Fixed Rate Trading

Xiangyang Wu: Structuring

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MARCH 2007

C M O S

Copyright 2007 J.P. Morgan Chase & Co. All rights reserved. JPMorgan is the marketing name for J.P. Morgan Chase & Co., and its subsidiaries and affiliates worldwide. J.P. Morgan Securities Inc. is a member of NYSE and SIPC. JPMorgan Chase Bank is a member of FDIC. J.P. Morgan Futures Inc., is a member of the NFA. J.P. Morgan Securities Ltd. and J.P. Morgan plc are authorized by the FSA and members of the LSE. J.P. Morgan Europe Limited is authorized by the FSA. J.P. Morgan Equities Limited is a member of the Johannesburg Securities Exchange and is regulated by the FSB. J.P. Morgan Securities (Asia Pacific) Limited is registered as an investment adviser with the Securities & Futures Commission in Hong Kong and its CE number is AAJ321 J.P. Morgan Securities Singapore Private Limited is a member of Singapore Exchange Securities Trading Limited and is regulated by the Monetary Authority of Singapore ("MAS"). J.P. Morgan Securities Asia Private Limited is regulated by the MAS and the Financial Services Agency in Japan. J.P.Morgan Australia Limited (ABN 52 002 888 011) is a licensed securities dealer.

Additional information is available upon request. Information herein is believed to be reliable but JPMorgan does not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. Past performance is not indicative of future results. The investments and strategies discussed here may not be suitable for all investors; if you have any doubts you should consult your investment advisor. The investments discussed may fluctuate in price or value. Changes in rates of exchange may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. JPMorgan and/or its affiliates and employees may hold a position, may undertake or have already undertaken an own account transaction or act as market maker in the financial instruments of any issuer discussed herein or any related financial instruments, or act as underwriter, placement agent, advisor or lender to such issuer. Clients should contact analysts at and execute transactions through a JPMorgan entity in their home jurisdiction unless governing law permits otherwise. This report should not be distributed to others or replicated in any form without prior consent of JP Morgan. This report has been issued, in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (all such persons being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other European Economic Area countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction.

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C M O S

Table of ContentsI. Introduction to MBS and CMO Market

II. CMO Principal Types

III. CMO Interest Types

IV. Recent Innovations in the CMO Market

V. Conclusion

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C M O S

MBS as a % of Fixed Income Market

Municipal

9%

Mortgage

Related

24%

Fed Agencies

10%

Money

Market

14%

Asset-

backed

8%

Corporate

19%

U.S.

Treasury

16%

Source: The Bond Market Association (as of September 2006)

Fixed income market compositionFixed income market composition

Total = $26.7 trillion

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Mortgage – Related Security Holdings by Investor2002-2006

(Dollars in Billions)

Mortgage – Related Security Holdings by Investor2002-2006

(Dollars in Billions)

Notes: Mortgage-related securities, or MRSs, include all securities or debt obligations collateralized by either residential mortgages or MBSs. Estimatesfrom Inside MBS & ABS based on available Federal Reserve Board data.* Other investors include hedge funds, nonprofits, state and local government, and other groups where MRS data is not available.

Source: Inside MBS & ABS

Who Buys MBS?A

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Investor Type 2002 2003 2004 2005 Midyear 2006 Change 05/06 Mkt ShareFannie Mae/Freddie Mac $1,109 $1,233 $1,261 $1,123 $1,150 2% 21%FDIC Commercial Banks $702 $776 $876 $897 $970 8% 18%Foreign Investors $235 $285 $490 $802 $850 6% 16%Mutual Funds $375 $387 $375 $405 $400 -1% 7%Personal Sector $120 $200 $235 $355 $360 1% 7%Life Insurance $235 $240 $265 $285 $300 5% 6%All Thrifts $210 $207 $234 $243 $243 0% 5%State/Local Governments $130 $165 $180 $225 $245 9% 5%Public Pension Funds $95 $120 $152 $180 $190 6% 4%Private Pension Funds $90 $105 $115 $160 $175 9% 3%FHLBanks $96 $98 $113 $122 $128 5% 2%REITs $13 $29 $79 $107 $112 4% 2%Property/Casualty Insurers $60 $55 $65 $90 $95 6% 2%Securities Brokers and Dealers $40 $35 $50 $95 $115 21% 2%Federal Credit Unions $25 $29 $28 $55 $71 29% 1%Subtotal $3,536 $3,962 $4,518 $5,144 $5,403 5% 99%Other Investors $40 $42 -- $45 $48 1%Total Outstandings $3,576 $4,003 $4,475 $5,189 $5,451 5.0% 100%

C M O S

FNMA Current Coupon Yield vs. UST 10 Year Yield

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4

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

M ar/04 Jun/04 Sep/04 Dec/04 M ar/05 Jun/05 Sep/05 Dec/05 M ar/06 Jun/06 Sep/06 Dec/06

Yiel

d (%

)

Current Coupon 10-years

Source: JPMorgan

C M O S

Why Agency CMOs?

To broaden the investor base by customizing cash flows for investor needs while providing key advantages over other instruments:

Excess Returns

Greater Liquidity

Virtually Zero Credit Risk

Can address the following specific needs of investors:

Enhanced Yields/Spreads

Targeted Average Life Profiles

Targeted Duration Profiles

Customize the risk/reward profiles for investor’s views on:interest ratesyield curve shapeprepaymentsvolatility

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C M O S

CMOs as % of the Fixed Rate MBS Market

0

10

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Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07

CMO

Issu

ance

($

Billi

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0

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% o

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Pas

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CMO Issuance % of Pass-Through

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C M O S

CMO Principal Types

SEQ – Sequential

PAC – Planned Amortization Class

TAC – Targeted Amortization Class

AD or VADM- Accretion-Directed/Very Accurately Defined Maturity

FFIEC Bonds

SUP - Support or Companion

Z - Accrual bond

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SEQs - Sequentials

Collateral principal payments are reallocated sequentially into a series of short, intermediate and long maturity bonds

Sensitive to prepayments:

Prepayments faster than expected: SEQs shorten

Prepayments slower than expected: SEQs extend

The shorter average life sequentials (that pay before the longer SEQs within the structure) provide prepayment protection for the longer average life SEQs

Shorter principal window than collateral

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C M O S

SEQ Yield Tables

Front SEQ

Last Cashflow (LCF) SEQ

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PACs - Planned Amortization Class

Principal repaid according to a schedule within a specified range of prepayment assumptions called PAC bands

Principal schedule provides protection from average life volatility and reinvestment risk associated with prepayments

Principal schedules are maintained by redirecting cashflow uncertainty to Support bonds

Average Life is less volatile with speeds outside the bands because the supports continue to provide stability

Corporate bond and agency bond surrogate

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PAC Yield Tables and Cashflow Graph

Yield table

Cashflow Graph

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C M O S

TACs - Targeted Amortization Class

Structured to pay principal according to a schedule determined by one constant prepayment speed - a “one sided” PAC

No protection against extension: TACs only have call protection because a TAC provides protection against faster but not slower prepayments

Prepayments faster than TAC speed: Excess principal to supports

Prepayments slower than TAC speed: TAC and Support extend

Offer higher yield than PACs based on increased extension risk

More call protection than a SEQ

Yield Table

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AD/VADMs - Accretion Directed / Very Accurately Defined Maturity

All cashflows are derived from the interest accretions of the Z bond

VADM tranches must mature prior to the start of the amortization on their corresponding Z because when the Z becomes current pay the Z accretion is no longer available to amortize the VADMs

Very stable bond since cashflow is from interest accretion which is NOT affected by prepayments

VADMs do not extend even under a zero prepayment scenario

No whipsaw risk

Pay up for the extension protection results in lower yields and better convexity

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VADM Yield Table and Cashflow Graph

VADM yield table in SEQ Z structure

WAL Graph

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FFIEC Bonds

Federal Financial Institutions Examination Council (FFIEC) derived guidelines to determine if MBS investments are suitable for US depository institutions

Bonds that meet these guidelines have a wider audience, are moreliquid, and trade at tighter spreads than comparable non-FFIEC average life bonds

FFIEC test:

Test 1) WAL must be less than 10 years

Test 2) +300 shift less than 4 years extension

-300 shift less than 6 years contraction

Test 3) +300 shift less than 17% price change

-300 shift less than 17% price change

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SUPs - Supports or Companions

Supports are cashflow shock absorbers for PACs

Faster prepayments - excess cash flow paid to supports providing call protection for PACs

Slower prepayments - any shortfall in cash flow is absorbed by supports which may not receive principal until PAC schedule is met, providing extension protection for PACs

High average life and cashflow volatility

Higher yields compensate for volatility

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Support Yield Table and Weighted Average Life

Weighted Average Life Graph

Sequentially Tranched Support

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C M O S

Z bonds - Accrual Bonds

No interest until principal payment window starts

Interest due is added to outstanding principal of the bond = Z accretion

Z accretion accelerates the maturity of shorter tranches or moreaccurately defines the maturity of others (VADMs)

Receive principal payments and interest once other bonds are retired

Addition of Z bond to a structure can improve the convexity of the other bonds by reducing extension risk

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Sequential Z Bond Yield Table & Cash Flow Graph

Cash Flow Graph

Yield Table

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Support Z Bond Yield Table & Cash Flow Graph

Cash Flow Graph

Yield Table

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Rocket Z Yield Table & Cash Flow Graph

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Type of support Z that has a possibility of paying off very fast (“rocket”).

Yield Table

Weighted Average

Life Graph

C M O S

CMO Interest Types

Floater

Inverse Floater

IO - Interest Only (Trust and Structured)

PO - Principal Only (Trust and Structured)

Inverse IO

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C M O S

Floaters

Coupons reset periodically, usually monthly, at a rate of an index, usually 1mLibor, plus a spread, know as the margin

Created with an inverse or inverse IO such that the weighted-average coupon of the pair is always equal to the underlying fixed-rate bond

Shorter and less negatively convex than underlying fixed rate

Offers protection against interest rate risk up to the cap

The cap adds some duration and negative convexity. Without a cap the duration would be negligible and convexity neutral

Shorter durations= less price volatility than fixed-rate CMOs unless rates rise and the coupon reaches its cap

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Floater Yield Table & Coupon Graph

Yield Table

Coupon Graph

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Support Floater Yield Table & Coupon Graph

Yield Table

Coupon Graph

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Inverse Floaters

Pays down simultaneously with their corresponding floater

Coupon falls when the index rate rises and are typically leveredpositions in the underlying fixed rate cash flow

High yields frequently compensate for the increased risks

Floored inverses: a “baby” inverse floater - coupon moves inversely but can never drop below a designated fixed coupon

Provide a way to leverage MBS if you are bullish on the MBS sector

Provide a way to leverage views in one package if you disagree with

forward rate curve

FED expectations

prepayment forecasts

volatility views

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Inverse Yield Table & Coupon Graph

Yield Table

Coupon Graph

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Floored Inverse Yield Table & Coupon Graph

Yield Table

Coupon Graph

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C M O S

IO - Interest Only

Receive only interest cash flow from the notional amount of the underlying bond

Since IOs do not pay principal, cashflows exist only if principal remains outstanding

The amount of cash flows received is highly dependent upon the amortization and prepayments of the underlying class

Benefit from slowing prepaymentsFaster prepayments reduce the notional balance more rapidly leading to smaller interest payments

Bearish security that usually have negative durations

Interest stripped from designated pools of collateral are known as STRIPS and are traded in liquid broker markets

Interest stripped from CMOs are known as Structured IO and can be customized for investor needs on:

lockout

PAC bands

underlying collateral STIPs

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IO Yield Tables

Structured PAC IO

Trust IO

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PO - Principal Only

Stream of principal payments purchased at a discount

Hedge for prepayment risk since POs benefit from faster prepayments:Principal is returned at par at a faster rate

Lower discount rates boost the price

The amount of cash flows received is highly dependent upon the amortization and prepayments of the underlying class

Bullish security with large, positive duration and positive convexity

Super PO’s provide a more levered prepay bet

Principal stripped from designated pools of collateral are known as STRIPS and are traded in liquid broker markets

Principal stripped from CMOs are known as Structured PO and can be customized for investor needs on:

lockout

PAC bands

underlying collateral STIPs

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PO Yield Tables

Structured SUP PO

Trust PO

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IO/PO Reports

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Trust IO/PO reports from JPMorgan provide daily price data:

C M O S

Inverse IO

Pays down simultaneously with their corresponding floater like an inverse except the Inverse IO does not pay principal

Coupon falls when the index rate rises and are typically leveredpositions in the underlying fixed rate cash flow

Faster prepayments reduce the notional balance more rapidly leading to smaller interest payments

Provide a way to leverage views in one package if you disagree with

forward rate curve

FED expectations

prepayment forecasts

volatility views

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Inverse IO Yield Table and Coupon Graph

Yield Table

Coupon Graph

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C M O S

Recent Innovations in CMO Market

AS/NAS – Accelerated Security/Non-accelerated Security

TTIB – Two Tiered Index Bonds

Super-Floater

Customized Floater: FHR 3069 CF

RELO – Relocation collateral deals

Pre-pay Linked Notes/Interest Accrual Notes (IANs)

Freddie Mac Reference Notes

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AS and NAS - Accelerated and Non-Accelerated Securities

AS security receives principal payments more quickly than its respective collateral.

NAS Security receives principal more slowly than its respective collateral

NAS + AS = SEQ

The AS bond receives the “accelerated” principal payments that would have otherwise been allocated to the NAS bonds

The NAS bond is locked out until the AS bond is paid off; then the NAS begins receiving its pro-rata principal payments

NAS is better than a PAC = no whipsaw risk

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AS and NAS Yield Tables

AS

NASnote the average life of 5.30 at 0 PSA

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TTIB - Two Tiered Index Bond

A type of inverse floater that pays a fixed rate as long as 1m Libor stays below a certain threshold

Once 1m Libor crosses the threshold the coupon declines on a levered basis within a corridor of rates until it reaches 0%

Essentially shorting an option that 1m Libor will not increase beyond a certain threshold

Compensating for shorting the option by getting a higher coupon.

Digital TTIBs: Once 1m Libor crosses the threshold the coupon declines immediately to 0%

Floored TTIB: Once 1m Libor crosses the threshold the coupon declines immediately to a fixed rate floor

Historical 1m Libor graph

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TTIB Yield Tables and Coupon GraphsDigital TTIB yield table

1 bp Corridor TTIB yield table

Digital TTIB coupon graph

1 bp Corridor TTIB coupon graph

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TTIBs with additional features

Locked-out Digital TTIB yield table Locked-out Digital TTIB coupon graph

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TTIBs with lock-out: coupon rate is not conditional on 1m Libor for an initial period, ensuring desirable rates over that period.

Initial reset date can be several years into bond’s lifetime.

C M O S

TTIBs with additional features (cont.)

Example: FHR 3140 CF- Is a regular L + 165 bp bond

for first 7 years, beforeconverting into a regularfloating-rate TTIB.

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Floating-rate TTIBs: when 1m Libor is below a threshold, bond pays as a floater.

Floating-rate TTIBs with lock-out: bond maintains its initial coupon formula for an initial period, regardless of 1m Libor.

C M O S

Super-Floater

A type of floater that pays a fixed rate as long as 1m Libor stays above a certain threshold (usually greater than current levels).

Essentially shorting an option that 1m Libor will remain below a certain threshold.

Compensated for shorting the option by receiving a VERY high coupon should 1m Libor go above the threshold.

Example: FHR 3111 HF (receives 66% coupon if 1m Libor > 6.5%)

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Coupon Graph

C M O S

Customized Floater: FHR 3069 CF

Classified on Bloomberg as “Complex” because the formula for calculating the payment is not the standard Libor + discount margin

Unique structure

Payment Formula:If Libor is less than 4.8%, bond pays Libor + 2.35%If Libor is greater than 4.8% but less than 7.15%, bond pays 7.15%If Libor is greater than 7.15%, bond pays 0%

Coupon Graph

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C M O S

RELO – CMO Backed by Relocation Mortgages

Relocation Mortgage: a mortgage made to a transferred employee to finance a home purchase at a new job location

Mortgage usually requires an employer to contribute to mortgage funding

Mortgage typically originated by an agreement between the employer and the lender under a relocation program administered by the employer or its agent

Prepayment speeds depends on typical prepayment behaviors and other RELO factors:

Whether the mortgages are made in connection with a permanent relocation of a corporate headquarters

The likelihood that borrowers will be relocated again

The frequency with which further relocations may occur

Historically this sector has fast prepay speeds

CMOs backed by RELO collateral usually trade at a deep discount

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RELO Yield Table and Weighted Average Life Graph

Yield Table

Weighted Average Life graph

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Prepay Linked Notes or Interest Accrual Notes (IANs)

Agency debt and MBS hybrid

Redemption schedule is based on a pre-selected reference pool

Like MBS (unlike agency debt) there is no explicit call date

Like agency debt (unlike MBS) there is a stated final maturity

Effective duration management tool for those who like MBS sector

Yield TableRecently-priced deals

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Freddie Reference NotesA Pre-pay linked note that trades live on Trade Web; an automated broker

Availability by all dealers on Trade Web meansBetter liquidity andBetter price transparency than pre-pay linked notes that do not trade live on Trade Web

Trades at slightly lower yields than other pre-pay linked notes due to the advantage of greater liquidity and greater price transparency

Trade Web Screen Offering:Yield Table

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Conclusion

As a premier investment bank, strives to be a leader in the CMO market

The CMO team’s recent production is growing rapidly:In April & May 2006, the #1 FNMA issuer!

The #3 overall conventional issuer (FNMA + FHLMC) over same period.

Over $5 billion in deal volume in those two months alone!

The CMO team can provide the following client needs:Unique trade ideas through structuring capabilities

Relative value analysis

Marked-to-market valuations & portfolio analysis

Liquidity through market making

Let the CMO team help you maximize the total return of your portfolio!

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