structured retail products -...

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Equities & Derivatives Research 16 February 2006

Structured Retail Products

Topic Paper Structured Products Research – Europe

Who said the sky was the limit? • Although the European structured products market has been gaining in

maturity in 2005, several countries continue to record tremendous rises in terms of issuance volumes. This dynamism has not only been seen in emerging countries on the continent, but also on well established markets such as Germany, Belgium and Spain.

• 2005 has also featured the extension of new asset classes as underlyings of exotic structures in the retail segment : among others, the healthy performances recorded by precious and base metals, energy and real estate fuelled demand for growth structures able to reap profit from these highly bullish momentums. In addition, they have also stirred interest - since some of them boasted high volatility levels, contrary to equities – more specifically for product ranges for which the investor is seller of this parameter. This interest in the underlying developed hand in hand with that of more straightforward payoffs capable of delivering the upside momentum observed on these various assets – this explains the numerous vanilla/Asian options, Best of Profile and CPPI funds marketed in 2005.

• As financial assets have continued performing healthily since the beginning of

the year, structures capable of delivering a strong performance about various assets will undoubtedly be successful again in 2006. But the renewed confidence in markets should nevertheless still be coupled with demands for capital protection given volatility levels for some of them, and stress due to the lack of knowledge in these products.

• Products enabling the investor to play the relative performance between two assets or the dispersion between several assets will undoubtedly be the second major development thrust for retail structured products in 2006. Indeed, they allow the investor to play the market in an original fashion, and fit with current trading interests of most structured products manufacturers.

• Among our directional bets, we suggest in 2006 gaining exposure to the Asian

and Japanese stock markets, as well as precious and base metals. In line with these objectives, we recommend three investment axes: 1/a growth structure – Rainbow - allowing the investor to play the momentum of a hybrid basket combining the Nikkei 225, gold and copper. 2/an Athena Express structure allowing the investor to reap profit from probable spikes in the barrel’s price owing to the turmoil in the Middle East. And 3/an outperformance deal that plays the performance spread between the Chinese stock market versus Brazil’s.

Authors Pierre-Olivier Cailleton, CFA [email protected] +33 (0) 1 40 14 26 05

Structured Products Research 16 February 2006

2 Equities & Derivatives Research

Contents

Page

Executive summary 3 The broad picture 5 Introduction 5 Volumes 10 Issuance matters 12 Underlyings 14 Growth versus Income 15 Capital Protection 16 Maturities 18 Main regulation and tax changes in 2005 18 Smaller European markets 20 Where should the SRP business head up in 2006? 24 Our directional bets for 2006 25 Pricing environment 27 What should trade in 2006? 31 3 suggested plays 33 Glossary 31 Contacts

Asia (excluding Japan) +(852) 29 78 3611

Austria +44 (0) 20 7595 8071

Belgium/Luxembourg +33 (0) 1 40 14 94 03

Canada +1 212 841 3741

Central & East. Europe +44 (20) 7595 8442

France +33 (0) 1 40 14 94 02

Germany +44 (0) 20 7595 8071

Greece/Cyprus/Malta +33 (0) 1 40 14 41 25

Israël +33 (0) 1 40 14 59 31

Italy +44 (0) 20 7595 8966

Japan +(813) 5290 8210

Middle East +973 17 524716

+973 17 524772

Netherlands +44 (0) 20 7595 8367

Portugal +33 (0) 1 40 14 22 73

Scandinavia +44 (0) 20 7595 8040

South Africa +44 (20) 7595 8690

Spain +33 (0) 1 40 14 22 82

Switzerland +33 (0) 1 40 14 94 01

UK +44 (0) 20 7595 8672

USA +1 (212) 841 3321



Executive Summary The structured products industry for retail clients has remained very dynamic throughout 2005 in Europe, with volumes increasing by around 20%: issuances have largely exceeded the €100bn mark. Nevertheless, countries differ in their way of welcoming this product range: developing markets such as Portugal, Greece and those of Eastern Europe as well as more mature ones such as Germany, Belgium and Spain all experienced strong growths in volumes, adding additional proof that development opportunities continue to exist in Western Europe. However, volumes in the United Kingdom have again staged a retreat.

Volume trends in major European countries

0

5

10

15

20

25

30

1999 2000 2001 2002 2003 2004 2005

Vol

ume

Issu

ance

(in

bn €

)*

France UK Belgium Spain Germany Italy

All amounts in euro. Conversion rates at 12/31/05

Source: BNP Paribas This observation is all the more surprising that it is in UK that funding conditions have remained the most favourable. As regards the Eurozone, even if interest rates were late 2005 lying at levels similar to those observed at the beginning of the year, they still reached lows over the period. And the interest rate hike observed across the Atlantic made the problem worse, raising the price of premiums based on US stocks and stock indices. In this tough structuring environment, and given that investors have again shown great interest for full capital protection, minimum guaranteed returns and/or high participation rates to the underlying’s performance, structurers had to resort to various solutions to meet these needs: use of high yield stocks as underlyings, reduction of the condition coupon value by those of the guaranteed coupons already paid, resort to underlyings more volatile than stock for structures where the investor is a seller of volatility, development of capital-at-risk and/or overperformance/dispersion play products… As implied volatility remained low for the main stock indices, it encouraged investors to remain volatility-buyers, most often via the purchase of products proposing participation in the rise in value of the underlying. This, combined with investors’ appetite to play the bullish momentum on equities helped the growth

Issuance volumes have clearly exceeded the 100bn€ mark in 2005 in Europe…

… and this despite tough structuring conditions…

… that did not prevent investors to ask for capital protection and guaranteed returns.

Growth structures stand out as the dominant pay-off profile.



structure profiles gain market shares and undoubtedly stand out as the dominant payoff. However, the outstanding evolution in 2005 has been the upsurge in demand for simpler payoffs, with exotism now lying more in the choice of the underlying rather than in the pay-off sophistication. As it has become possible to gain exposure to other asset classes than the classical stock, bond and foreign exchange markets, issuers consequently promoted exposures to hard and soft commodities, energy, real estate… The outstanding performance recorded by some of these asset classes over recent years is obviously the main driver behind this evolution. Note nevertheless that this situation is far from being commonplace: indeed, asset classes have rarely been so synchronised. The good progress of asset classes will further boost individual investments in financial products in 2006. And since structured products make it possible to access all asset classes and to offer capital protection in part or in full, they will remain a key investment vehicle in this environment. Investors will continue to look for products that can reap profit from a simple directional momentum-type scenario, in a similar fashion to what has already been observed on the UK markets for several years. The so-called growth profiles should therefore remain the dominant theme. Capital protection will remain a highly demanded feature as the resort to more exotic assets such as commodities or energy will also be framed by security given their high volatility and the lack of knowledge towards them. But demand for guaranteed coupons could wane as financing conditions remain difficult and the bullish momentum observed on most assets pleads for immediate exposure. Lastly, outperformance and dispersion structures are likely to be part of the preferred products in 2006 thanks to their pricing advantages and ability to deliver returns unlinked to the market bias. As regards our directional bets for this year, we keep a bullish stance on stock markets, with a preference for those of emerging economies, notably China and India, given our economists’ growth expectations in these regions. We would also seek exposure to base and precious metals as we expect demand for such products to remain strong. Conversely, the end of the monetary tightening and of the fiscal stimulus as regards repatriation of profits made abroad for US companies should result in a renewed weakness in the dollar versus main currencies - thus the relevance of quanto pay-offs for non-USD denominated investments. We consequently suggest 3 plays that fit in our directional scenario:

A GROWTH PLAY Rainbow - allows the investor to play the momentum of a hybrid basket combining the Nikkei 225, gold and copper.

AN INCOME PLAY Athena Express structure - allows the investor to reap profit from probable spikes in the barrel’s price owing to the turmoil in the Middle East.

AN OUTPERFORMANCE PLAY Pacific - plays the outperformance of the Chinese stock market versus Brazil’s.

Exotism now lies more in the choice of the underlying rather than in the pay-off sophistication.

Structured products are a valuable investment vehicle when it comes to investing in volatile, ill-known assets.

Our directional bet for 2006 favours equities, base and precious metals



2005 - The broad picture

Introduction Although the structured products industry for private individuals is day by day gaining in maturity, it has remained very dynamic throughout 2005 in Europe, with volumes increasing by around 20%. Issuances have now largely exceeded the €100bn mark, and on the continent the total has neared €115bn. Nevertheless, countries differ in their way of welcoming this product range. For instance, Germany, Belgium and Spain have experienced sharp increases, while volumes in the United Kingdom have again staged a retreat. This observation is all the more surprising that it is in UK that funding conditions have remained the most favourable. Indeed, as regards all countries in the Eurozone and Switzerland, even if interest rates were late 2005 lying at levels similar to those observed at the beginning of the year, they still reached lows over the period - please refer to the graph on the left below. The interest rate hike observed across the Atlantic made the problem worse: it raised the price of premiums based on US stocks and stock indices – which obviously has to be linked with the sudden interest in options on Japanese stock indexes. As implied volatility remained low for the main indices – please refer to the right graph below - it encouraged investors to remain volatility-buyers, most often via the purchase of products proposing participation in the rise in value of the underlying over the investment period. Of all European countries, only Italy has marketed mainly income products in 2005, whereas growth structures were gaining additional market share in most other regions – sharp rises in stocks, and more generally in all asset classes over the period, were also concerned by this craze, since investors were willing to benefit from this favourable momentum.

Changes in 3Y swap rates and 3Y implied volatilities in 2005

0

1

2

3

4

5

6

Jan-0

5

Feb-05

Mar-05

Apr-05

May-05

Jun-0

5Ju

l-05

Aug-05

Sep-05

Oct-05

Nov-05

Dec-05

3Y s

wap

rat

e (%

)

EUR GBP USD CHF

12

13

14

15

16

17

18

19

20

21

Dec-04

Jan-0

5

Feb-05

Mar-05

Apr-05

May-05

Jun-0

5Ju

l-05

Aug-05

Sep-05

Oct-05

Nov-05

Dec-05

Impl

ied

Vola

tility

(%)

S&P500 FTSE100 NIKKEI225

SMI EUROSTOXX50

Source: BNP Paribas-Datastream In 2005, investors have again shown great interest in products fully protecting their initially invested capital, or guaranteeing, in addition to this protection, a minimum return and/or high participation rates to the underlying’s performance.

The industry remained very active in 2005 with volumes up 20%

Growth profiles clearly dominate as investors are eager to play the momentum



Given a tough structuring environment, structurers have resorted to various solutions to meet these needs, all the more since investors proved particularly inflexible towards a possible maturity extension of these products:

• Use of baskets of high yield stocks or indices made up of high yield stocks such as the DJ Stoxx (and the Eurostoxx) Select Dividend 30, the Divdax, the 15 DJ Asian Titans shares (Asian shares paying the highest dividends over the last 12 months).

• For structures paying guaranteed coupons, the ability for these

products to reduce the value of the conditional coupons or those of the capital gain to be paid at maturity by the guaranteed coupons paid in the early years of the product’s life. This is reminiscent of the Best of Structure we used to see some years ago, paying at maturity the maximum between a fixed coupon and an exotic option. In both cases, the product includes an OTM call, and starts delivering returns in excess of what is already guaranteed once the pay-off of the underlying exceeds the value of the guaranteed coupon.

• Resort to underlyings more volatile than stock underlyings used for

options where the investor is seller of volatility: therefore we saw the development of structures such as Reverse Convertible, Athena, Stellar, Coupon Comet, Ariane or Wedding Cake on particularly volatile assets such as oil, natural gas or base metals. Please refer to the graph below.

3Y implied volatilities for Eurostoxx 50, Copper, Oil (WTI) and GSCI at 01/15/06

0%

5%

10%

15%

20%

25%

30%

35%

Stock Index Copper Oil GSCI

Ass

et's

3Y

impl

ied

vola

tility

Source: BNP Paribas

• Development of capital-at-risk products (still a minority) as there is a growing number of investors that show renewed confidence in stock markets and are probably eager to enter into products with higher return potential. Thus the development of different capital-at-risk features called: 1/‘soft protection’, already popular in 2004 but mostly restricted to the private banking segment - which corresponds to a down and in put, most of the time with a continuous or discrete



activating barrier around 60% of the underlying’s initial price, and an ATM strike - mostly used with Reverse Convertible and Athena type structures, and 2/‘partial protection’ which consists in giving up 10 to 20% of capital protection for a higher participation rate to the upside potential of the selected underlying - mostly used with simple growth pay-off through Asian and Vanilla calls.

• Development of overperformance/dispersion play products such as

those that allow investors to play the outperformance of a selection of Chinese stocks over some US and European blue chips, to deliver a high gearing to the average of the absolute deviation of each stock from the basket’s mean or to pay the difference between the best and the worst performance(s) recorded among a basket of stocks. From a marketing standpoint, these pay-offs have developed due to their innovative ability to decorrelate their returns from the markets’ bias and to propose performance arbitrages between assets. However, the development of this type of payoff can also be explained by the fact that numerous structurers increasingly need to change trading positions that are sellers of correlation - brought about by the marketing of options on baskets of stocks such as Comet, Ariane, Driver, Worst Of, Venus and exotic variants of cliquet options – which may partly explain why correlations between indices have been falling for the past few months. Lastly, this type of option is little sensitive to forward prices: this advantage is all the more appreciable when it has US stocks among its underlyings.

However, as regards the structured products industry, the outstanding evolution in 2005 has been the growing demand for simpler payoffs, with particularly close attention paid to the choice of the underlying. This trend, which had started in 2004, has been clearly confirmed in 2005 in all countries in continental Europe, and makes them increasingly look like the more mature UK market. This trend going towards simpler return profiles translates into a massive use of vanilla and Asian options (capped or uncapped), CPPI-type funds, most often ‘lookback’ (the development of which is worth mentioning in France) and the development of the Best Of Profile, an option which was created late 2004 and brought about significant amounts in 2005. In terms of underlyings, supply has changed over the past years and is now more complete: with regard to structured products, it is possible to gain exposure to other asset classes than the classical stock, bond and foreign exchange markets. Issuers consequently promoted exposures to hard (base and precious metals) and soft (agricultural) commodities, energy (oil, gas, electricity) and real estate (HHPI – specific to the UK market and the EPRA category). 2005 also featured the ‘sustainable development’ theme with the use of indices such as the ‘DJ Sustainability index’ and some baskets of selected stocks related to the water, renewable energy and biotechnology sectors. The outstanding performances recorded by some of these asset classes over recent years are obviously the main driver behind this evolution. A great deal of investors now wishes to be exposed to asset classes that have largely outperformed stock markets over recent years – Please refer to the graph on next page for comparative performances among assets.

The demand for simple, more straightforward pay-offs swelled in 2005

Exotism now lies in the underlying’s choice



Assets Comparative Historical Performances : Eurostoxx50 - EPRA euro zone – Copper - Oil (WTI)

0

50

100

150

200

250

300

350

Jan-0

2

Apr-02

Jul-0

2

Oct-02

Jan-0

3

Apr-03

Jul-0

3

Oct-03

Jan-0

4

Apr-04

Jul-0

4

Oct-04

Jan-0

5

Apr-05

Jul-0

5

Oct-05

Ass

et's

per

form

ance

(in

% -

in d

omes

tic c

urre

ncy) COPPER (x3)

OIL (x3)

EPRA euro zone (x2)

Eurostoxx 50 (x1)

Source: Bloomberg



2005’s bright ideas Despite this reversion to more straightforward pay-offs, the structured products activity remained creative in 2005 with several noteworthy innovations.

INNOVATION

PRODUCT NAME

ISSUER TARGET MARKET

COMMENT

1

The indexation to the underlying’s upside activates only if all the basket’s components show positive returns at maturity.

Bolsa Garantizado 5

Caja Laboral

Spain

This feature makes it possible to significantly lower the call option’s premium, even for volatile underlyings. The upside potential remains similar to a traditional call option, should all the basket’s components show positive returns over the investment period.

2

The client can early terminate the investment after 4 years, provided the underlying has breached an upper barrier at that date. He can also choose to remain invested for the 3 remaining years and receive periodic predetermined guaranteed coupons.

Doble Oportunidad

SCH

Spain

The client is given the choice to terminate the investment after 3 years. Thus he can make at that date an investment decision that fits his market’s view. Up to now, the client had absolutely no control over the early termination feature.

3

Conditional coupons paid in the early years, guaranteed coupons afterwards.

IndexVita Lock-In

Oggi 2

Capitalia

Italy

Products usually pay guaranteed coupons in the early years and conditional coupons afterwards. This product proposes to reverse this feature, what makes more sense from a fundamental point of view. From a pricing standpoint, to pay guaranteed coupons in the remaining years of the product’s life lowers the option’s premium.

4

Early Termination occurs when the sum of the periodic coupons paid reaches a pre-determined level.

Target Coupon

Citibank

Italy

This represents a cheaper alternative to the traditional ET process as the maximum potential return is already known at inception.

5

Lookback CPPI with only partial

capital protection.

Sterling Assurance

Zurich

UK

Typically, CPPI funds fully guarantee the capital at maturity. 2005 saw the development of CPPI funds partially protecting the capital at maturity, thereby enabling the investor to gain greater exposure to the risky asset.

6

Capital at risk with loss being

one tenth of underlying downfall at maturity.

Protected

Commodities Turbo

Dawnay Day

Quantum

UK

This is a special case in the universe of non-guaranteed capital structures. The maximum loss in capital is 10% in this case. Putting capital at risk makes it possible to give a significant boost to the potential return of the investment in this specific case as this underlying benefits from the ‘backwardation’ effect.

7

Cliquet on basket with quarterly re-weighing on best-performing

components.

Momentum Tracker

Plan

Nvesta

UK

This option is a cliquet that enables the investor to trade the momentum. This feature comes at roughly no additional cost compared with a regular cliquet.



Volumes

Volume issuance in main European markets

0

5

10

15

20

25

30

France UK

Belgium Spa

in

German

y*Ita

ly

Scandin

avia

Netherlan

ds

Portug

alV

olum

e Is

sued

Volume 2004 Volume 2005


Source: BNP Paribas * Volumes for Germany do not include the vanilla certificates. Total issuance of certificates, bonds and funds would amount to €80bn in 2005.

The European Structured Retail Products market is in rather good shape in Europe with volumes and issuances up in a majority of countries. The size of the European market is now believed to exceed €100bn (around €115bn), a threshold that issuers failed to breach in 2004. The 7 major countries (France/Belgium/UK/Spain/Germany/Italy/Netherlands) continue to dominate, accounting for 90% of the total amount issued. The other good news is that not all of the issuance’s growth comes from emerging economies. Some ‘mature’ markets such as Germany, Belgium and Spain experienced strong growths in volumes, adding additional proof that development opportunities continue to exist in Western Europe. The German market has seen a tremendous increase in certificates issuances, thus appealing to many domestic but also foreign players all interested in benefiting from a strong growth momentum and comfortable margins. If one bad news had to be mentioned, it would be that of declining volumes observed in the UK market, which confirm that this particular market has been on a downward trend since 2001. Previous declines had been justified by the techno bubble burst in 2000 and tighter regulations and constraints for issuers when marketing SCARP products. In the last two years, the structured products industry had to compete with direct equity investments whose high dividend paid to shareholders make them particularly attractive to UK investors’ eyes.

The German market has experienced a tremendous increase in certificates

… whereas the UK can’t contain declining volumes



Volume trends in major European countries

0

5

10

15

20

25

30

1999 2000 2001 2002 2003 2004 2005Vo

lum

e Is

suan

ce (i

n bn

€)*

France UK Belgium Spain Germany Italy


Source: BNP Paribas Volume issuance from 1999 to 2005 unveils discrepancies among main European markets. Clearly Germany and Belgium are the most active, with volumes issued exploding since 2001. Spain also rose to a similar extent over the period, but the pace has lost momentum over the last 2 years, with volumes in 2005 hardly higher than in 2003. France and Italy are in the middle while the UK continues to suffer from a declining momentum. Note that Belgium is the country boasting the highest volumes issued per inhabitant (€1,700/inhabitant).



Issuance matters

General overview Worth mentioning Market share by issuer type

FRANCE • Still concentrated market with

majority of issues made by a restricted number of institutions.

• Market widely dominated by banks

with most active issuers being Caisse d'Epargne, Credit Agricole, BNP Paribas and Societe Generale.

• IFA (Independent Financial Advisors)

made significant inroads in the French market in 2005, with among new entrants Arca Patrimoine, Patrimoine and Finance, Edwards Solutions, Guardian Vie and Nortia.

• Insurance companies also gained

market share in 2005, but they remain very small compared with banks.

Banks

Life Companies

IFA

Independent AM Firms

Post

UK • The fall in volumes occurred

together with a lower amount of issuances. Lower swap rates combined with higher volatility levels actually made things harder for issuers to propose attractive pay-offs. Also structured products had to compete with generous dividend policies from direct investments in stocks. Most active issuers were Bristol & West, Natwest Life and Barclays, Woolwich Plan Managers and Halifax.

• Already well developed in the UK in

previous years, the CPPI management process thrived in 2005, accounting for half of the open-ended funds active on this market.

Life Companies

IFA


Post

Offsh.Bank

Banks+Build. Societies

Offsh. AM

Offsh. Life Company

BELGIUM • Still the most concentrated market

with only two banks leading the game: KBC and Fortis. Dexia and SG also dominate, though to a much lower extent.

• The ‘DLU’ (declaration libératoire

unique) implementation in 2005 encouraged Belgian citizens to bring back their savings hidden in Luxembourg. This event largely explains the rise in amounts collected over 2005.

• It is worth signalling the development

of SG in Belgium with around three times as much issuances striking in 2005 when compared with previous year.

Banks

Life Companies




General overview Worth mentioning Market share by issuer type

SPAIN • Santander, La Caixa and BBVA

made the running in 2005 along with local savings banks (the latter account for half of total issuance seen on the Spanish market in 2005).

• The Spanish market has experienced

significant changes in 2005 with a surge in volumes, in number of issuers and issuances.

• Nevertheless, a closer look unveils

that this issuance’s dynamics is mostly attributable to the usual biggest retail networks. Issuers such as e-banks, fund managers, the Post-Office, and insurance companies develop, but volumes remain limited.

Banks

Independent AM/Life

Comp/Post

GERMANY • Number of issuances striking in

2005 has surged, the German market being still dynamic with certainly further room to grow before being considered as mature. Issuances continue to be dominated by banks with Deutsche Bank, Commezbank, ABN Amro and DZ Bank being most active.

• Both volumes and the number of

products issued exploded in 2005. The relative youth of the German market and the opportunities that go with it continued to attract foreign players such as Barclays, Calyon and Nomura in 2005.

• Interest in certificates products

exploded, the number of issues being up by 60% over the year. And the trend should persist in 2006 as asset management companies such as DWS that benefit from a strong distributing power are starting to issue certificates.

Banks

Other


ITALY • One of the least concentrated

market with Spain with many different active issuers. Market leaders remain almost unchanged between 2004 and 2005, being again Banca Intesa, Capitalia, BNL and BNL Vita.

• Activity proved slightly more active in

2005 despite the new ISVAP regulation for Italian insurers (please see ‘Regulation and tax changes’ for details). The Consob actually softened its requirements as regards the number of stocks to be inserted in the basket, what helped the banking segment to recover from last year’s downfall.

• Another interesting development was

the co-operation (i.e. selling the same structure) between Poste Italiane (Poste Vita) and La Poste, and between Adequity (SG France) and Inora Life.

Banks

Post

Life Companies

Offsh. Life Company



Underlyings The development of new asset classes as underlyings of options as well as the bullish momentum – experienced by most of them - have considerably changed the structured products’ scene. Once pushed into the background in favour of options’ pay-offs, underlyings are now seen as a key element in the structure. 2005 will undoubtedly remain as the year featuring exposures to gold, energies, base metals, and other underlyings that were up to now only accessible by the private banking industry.

EQUITY FIXED INCOME MANAGED/HEDGE FUNDS

COMMODITY OTHER

Belgium STRONG – Mostly

based on baskets of stocks (uncapped calls, worst of, digital cliquets, ladder).

MEDIUM – Most are steepeners. Some used within hybrid basket (Best Of Profile).

WEAK – 1 RC based on electricity, hybrid (best of Profile) including oil and copper. Note nevertheless that hybrids were ‘non-existent’ in Belgium in 2004.

Trades foreign currencies fluctuations versus the euro.

Germany

STRONG – Almost all certificates are equity linked. Little appetite for emerging stock markets, even eastern Europe. Frequent use of stock baskets within Worst structures and single index (such as Eurostoxx 50) within Athena structures and Bonus Certificates.

WEAK – some steepeners.

WEAK – Frequently used in 2004, hedge fund underlyings have experienced a sharp decline in 2005 given the poor performances delivered in recent years.

STRONG – strong demand for oil and to a lower extent for copper, gold, and renewable energies.

Several certificates combining fixed income and equity underlyings. Some Rainbow hybrids combining more fancy assets such as energy and commodities but their development remains limited.

France

STRONG – A majority of single index and basket of indices. Several products on baskets of shares (Most of the time Worst Of structure).

WEAK – Only within a hybrid structure such as Best of Profile. Typically Iboxx.

MEDIUM – mostly within CPPI and Best of Profile structures.

NO – Commodity still not allowed as underlyings for products packaged as funds.

1 CPPI on CDS.

Spain

STRONG – Spain continues to make a wide use of domestic underlyings (IBEX 35 and Spanish stock baskets via Comet coupon type pay-off). Very limited use of emerging markets’ equities (only Asian indices). Development of the DJ EurostoxxSD30 later in the year.

WEAK – some Euribor based structures were seen, along with Iboxx (the latter being combined with other asset classes).

MEDIUM – Managed funds were notably used as underlyings for CPPI and Best of Profile options. Despite the increased flexibility for the marketing of hedge fund based products, none were seen in 2005.

NO – Commodity linked products did not sell in Spain.

Spanish investors surprisingly accepted exposure to Forex, real estate (EPRA), DJ Sustainability Index.

Underlyings have become key elements



EQUITY FIXED INCOME MANAGED/HEDGE FUNDS

COMMODITY OTHER

Italy

STRONG – Classic world index baskets, Eurostoxx 50 and S&P MIB widely used. Also many options based on stock baskets. Rising interest in Asian equities. CECEEUR used once.

MEDIUM – Wide use of CMS rates, and occasionally Euribor, Tec 10 and Italian Sovereign bonds. Steepeners used to be popular early 2005 but its appeal lost steam as the year went by.

WEAK – Most managed funds played via CPPI structures

MEDIUM – Several structures playing the growth momentum on commodities, notably Himalayas

Underlyings type were clearly more diversified in 2005 with inflation linked products, hybrids (combining EPRA, Iboxx and equity), FX exposure, and interest in the sustainable development theme and high yield stock indices. Hybrids were mostly traded via Himalaya, Stellar and Best of Profile.

UK

STRONG – The Footsie used as single underlying clearly continues to dominate. A vast majority of products is equity linked, mostly main world indices, some interest in Asian equities but still use of the traditional Hang Seng and Nikkei (few fancy choices). The high yield theme was barely played, but one CPPI fund on the DJ Select Dividend Index.

WEAK – Very few products being pure fixed income on the retail side. Many more on the PB segment though, especially for USD denominated investments. It is also worth mentioning some inflation related pay-offs.

MEDIUM – Managed funds used several times, not only within a CPPI structure. Note nevertheless very little interest in hedge funds underlyings.

MEDIUM – Several structures based on commodities, mostly to play the momentum such as Bull and Bear note.

Several products did propose exposure to real estate (even one on Bulgaria), again HHPI but more and more use of the EPRA UK. Interest in hybrid underlyings is nevertheless rising in 2005, with structures combining equity, real estate, commodity and/or forex. The best of profile structure –hybrid version- is also taking a start at the end of the year.

Growth versus Income As stock markets but also other asset classes have been doing well in recent years, growth pay-off profiles have aroused additional interest to investors’ eyes. Growth profiles actually dominate in all main European countries, except in Italy where regular coupon payments remain key. In the UK, a place where the growth/income allocation used to be more balanced, 2005 confirmed the undisputable victory of the growth profile. It is true that favourable funding conditions and low volatility levels were a blessing for this type of pay-off, issuers having been able to offer - in a majority of cases - both full capital protection and above 100% gearings to standard vanilla or Asian call options to the selected underlying on standard maturities of 5 years. Besides, the fall in income products is still due to regulatory constraints on SCARP products, most of them corresponding to income pay-offs such as RC and Athena type.

As most asset classes are doing well, interest for growth profiles increases



GROWTH

INCOME GROWTH & INCOME

Belgium

STRONG – Many uncapped calls with <100% capital protection, best of profile, Asian.

WEAK – RC, range accrual, and some fixed income products.

WEAK – Mainly Worst of.

Germany

MEDIUM – Most growth pay-offs linked to Worst of and Arlequin.

STRONG – Athena.

STRONG – Bonus Certificates.

France

STRONG – Largest issuances present growth profiles. Best of Profile, CPPI, capped calls, exotic Himalayas.

WEAK – Mostly for the IFAs and PB segments.

MEDIUM – Almost all the worst of structures provide guaranteed coupons in the early years of the product’s life.

Spain

STRONG

WEAK – Very few pure income products, sold as coupon comet or Athena type products.

MEDIUM – One third of issuances proposed guaranteed coupons, sometimes just one month after the product started. Mostly growth structures delivering guaranteed coupons - most of the time issued by savings banks.

Italy

WEAK – Few pure growth products, with often capped return potential. l

STRONG – Conditional coupons paid when underlying(s)s show(s) a minimum required performance over the period. Many Ariane, Wedding Cake and Podium.

STRONG – As majority of growth products also provide guaranteed coupons. In the more exotic category, many Napoleon and Hexagone type options.

UK

STRONG – A majority of uncapped vanilla and Asian calls. A rather favourable funding environment and low volatility levels allowed for aggressive gearings on the upside.

WEAK – Few pure income products, with RC type options still discarded by investors. Nevertheless some conditional coupons, digital pay-offs Ariane Range and Coupon Comet type options.

MEDIUM – Increasingly popular with many growth pay-offs delivering guaranteed coupons.

Capital protection Above 100% guaranteed return has clearly been on demand in most countries. However, in countries such as Belgium, this feature has lost steam in 2005. Some changes were also noticed in the UK market with more and more above 100% capital protected products structured the continental way instead of the traditional 50:50 notional split between a money investment and an exotic pay-off.



100% PROTECTION

>100% PROTECTION SOFT PROTECTION <100% HARD PROT.

Belgium

STRONG

WEAK – What makes the Belgian market different YoY. Many proposed with fixed income linked products such as steepeners or worst of on share baskets. Also conditional coupons whose value is reduced by the coupons having detached earlier.

NO

WEAK – Mostly growth products with aggressive participation rates in the upside.

Germany

STRONG – Again, capital protection mostly proposed with bonds, typically with Worst of, Rainbow and Arlequin options.

WEAK – Few bonds and certificates did propose the guaranteed return feature.

STRONG – Best sellers such as Bonus Certificates and Athenas typically are products that provide soft protection.

NO

France

STRONG – Though the proportion has tended to shrink compared with 2004. Protection much more on demand on the more retail side of the market.

MEDIUM – Several products have been able to guarantee coupons in the early years of the product’s life, mostly using Worst Of type structures.

MEDIUM – more popular for PB and IFA products (Athena type pay-offs) but start existing on more retail segments. Most based on ATM DIP or OTM vanilla put.

WEAK – Few examples. Soft protection clearly dominates.

Spain

STRONG – One of the most conservative markets in Europe with a clear demand for safety.

STRONG – around one third of the products issued in 2005 provided guaranteed coupons. This contrasts with the situation in 2004 where above 100% returns were barely proposed.

WEAK – few products provided soft capital protection (some Athena type structures) mostly for the private banking segment.

MEDIUM – Several products did propose to put capital at risk, though to a very limited extent (around 85-90% protection) to finance aggressive gearing on the upside

Italy

MEDIUM – as most products, income and growth, pay guaranteed coupons

STRONG – guaranteed coupons can be paid in early years, throughout the product’s lifetime, or in the remaining years of the product’s life, or even added to a forward start Best Of option.

WEAK – Almost no structure putting capital at risk.

WEAK – As for soft protection, barely any structure proposing capital protection.

UK

STRONG – A favourable funding environment made it easy to propose both capital protection and attractive pay-offs.

MEDIUM – many products offering guaranteed coupons, either through the traditional 50:50 split in notional half invested in a money market investment, half in an exotic structure. However, a favourable funding environment on low volatility levels on equities have allowed the delivery of guaranteed returns the ‘continental’ way. In some cases, investors were even given the possibility of trade-off between the value of the guaranteed coupon and the gearing to the underlying’s growth potential.

WEAK – very few products with a DIP embedded.

MEDIUM – As in recent years, many investors were given the choice between the degree of capital protection and the gearing rate to the underlying’s growth potential.



Maturities Nothing new regarding maturities in main European markets as they tend to be similar year on year within each country. An unfavourable funding environment should have resulted in longer maturities but European investors appeared rather inflexible on that matter. Minimum, maximum and most traded maturities in main European countries

0

2

4

6

8

10

12

14

16

Belgium

German

y

France

Spain

(depos

its)

Spain

(Funds

)Ita

ly UK

Scandin

avia

Easter

n Euro

pe

Mat

urity

in y

ears

Most traded maturities (80% of issued deals)

Source: BNP Paribas Main regulation and tax changes in 2005 CESR, the association covering all local regulators from various EU countries, has attempted to clarify the list of assets eligible to UCITS funds: notably, commodity indices were included in the list and Hedge Funds – even under an index form – were excluded. The latter stance is nevertheless under discussion and a different outcome could well be decided by next October. The CESR’s conciliating tone regarding the use of commodity indices should boost issuances of structured products based on this type of underlying, notably in countries where they were still banned by legislation last year. The implementation of the PERP (Plan d’Epargne Retraite Populaire) in France has contributed to the extension of subscription periods which used never to exceed a few months. Several products have indeed displayed subscription periods of around 5 years in order to best match the regular payment principle that goes with this type of investment. The tax system regarding savings products in Germany should be homogenised in 2007. To date, products with maturities exceeding one year and with no guarantee on the initially invested capital are tax-exempt – that also explains why structures such as Athena and Bonus Certificates prove hugely successful. Undoubtedly, a change in the tax system would multiply the number of



maturities of less than a year and there would be fast-growing demand for products offering capital protection and/or guaranteed returns. In Spain, the regulation linked to the marketing of Hedge Funds is experiencing a few changes: the CNMV now authorises so-called ‘free’ investment funds having almost inexistent management constraints, thereby enabling the investor to add alternative management principles. Nevertheless, constraints regarding minimum subscription and disclaimers are so high that marketing this type of products to retail clients is impossible. Only funds of these free funds can be proposed to the retail clientele. When it comes to alternative funds or indices as underlying of options, Spanish regulation authorities are not ready to accept them yet.Only debt securities commercialised in public offering are likely to benefit from this type of underlying, in the passporting (see below for details) framework. Passporting, made possible through the 2003/71/CE Prospectus directive dated of 4 November 2003, enables the issuer to list at the host State member stock exchange (typically at the Luxemburg stock exchange) any investment product proposed under the form of debt security; thus, on delivery of a certificate of approval from the home State member together (if applicable) with a translation of the summary note prepared by the issuer, the latter is marketable to retail investors in any of the 25 EU country and also in Island, Norway and Liechtenstein. De facto, the local authority’s decision-making power is limited to marketing, publicity issues. Countries had, in theory, until 1st July 2005 to transpose this directive into their law. However in practice, several countries such as Italy do not fully comply with the passporting procedure. Passporting is now in use in countries such as Germany, Austria, Belgium, and in the Netherlands, countries which already admitted the mechanism for mutual recognition of prospectuses that has been improved by the Prospectus directive. Demand for structured products from Eastern European investors – notably Poland, Hungary and Czech Republic is escalating. The first effect of passporting by harmonising public offering rules, to allow in certain jurisdictions to market some types of structured products which were not permitted before. In Italy, life-insurance companies had to put on 1 December 2005 their businesses in compliance with the 551/D circular issued by ISVAP. This had an impact on the use of external guaranteed funds in unit-linked as insurance companies were no longer allowed to retrieve reconveyance on management fees on these underlying funds. In Greece, even if legislation – expected since 2004 – regarding the possibility to use the ‘pension funds’ envelope is going through changes in 2006, it should first have no impact on the marketing of structured products to Greeks individuals. Indeed, problems are still numerous. In other words, if legislation changes in 2006, the first impact on activity won’t be felt before 2007.



Smaller European Markets AUSTRIA Volumes are up, the dynamism of the market being similar to that of its German neighbour. The market continues to be dominated by banks (with a rough 90% market share). Life insurance companies tap most of the remaining 10%. Given its limited size, the Austrian market does not attract as many investors as its German counterpart but many products bought by Austrian retail clients are issued by German institutions. Issuances amounts cannot be compared with what is done in Germany, barely exceeding €400m as regards biggest issues. Most active issuers are the usual suspects Erste Bank, Oevag, RCB and Bank Austria. Investors’ preferences clearly concentrated on the income and growth and income categories: most popular structures belonged to the Worst Of, Ariane and Athena families. The growth theme was mostly played through the Arlequin option, often in its lookback version. As regards underlyings, the traditional baskets of blue-chip stocks and single indices such as the Eurostoxx 50 remain bestsellers. More exotic themes such as Eastern Europe and Asian emerging economies that investors already traded in 2004 have further appealed to investors in 2005. NETHERLANDS The size of the structured retail products market in 2005 is very similar to the previous year - around €10bn. Nevertheless, the fixed income/equity split was not finely balanced in 2005, with fixed income issuances being top of the league - many Steepeners and CDOs - despite unfavourable moves on the rate curve. There is no change to signal in terms of main issuers year-on-year, the most active still being ABN Amro, RaboBank, ING and Robeco. Though Stellar and periodic coupon pay-offs continued to attract investors in 2005, the interest in more vanilla, growth style options such as Asian and/or Capped calls has developed. The other change worth mentioning is the acceptance of capital-at-risk structures such as the Athena that were barely proposed in 2004. Rising stock markets clearly had an impact on the Dutch investor’s psychology who was willing to take exposure to growth, non capital protected pay-offs in 2005. The Dutch market nevertheless remains very specific as regards the underlyings used. Modest interest was shown in emerging stock markets and real estate was traded in a protective way. Best of Profile on Hybrids have not appealed to investors either. Among new assets classes to be proposed within the structured products asset class, only commodities succeeded in arousing some kind of interest. Another trend worth signalling is the growing appetite for mutual funds based products - up to now index linked products were preferred over mutual fund linked products.



SCANDINAVIA It has been a very active year, notably in Sweden, with renewed confidence back on stock markets. Consequently, volumes recorded headed higher between 2004 and 2005, climbing from 7 to €8bn. The Scandinavian market remains dominated by banks that account for around 60% of issuances, brokers ranking second and IFA’s tapping the remaining 10% of the market. The strong performances of Scandinavian equities (the Norway and Swedish markets were up 35% and 30% respectively in 2005) has made it possible to slightly erode the domination of the FX linked structures, a trend we expect to strengthen throughout 2006. Most equity linked pay-offs were of Stellar and Asian call type. Though investors are still conservative regarding the capital protection, boldness can nevertheless be found in their appetite for commodities, hybrids and emerging stock markets (including Asia, Eastern Europe and Russia). Like in many other European places, the hybrid version of the Best Of Profile turned out to be a best-seller. EASTERN EUROPE 2005 was another very active year for structured products in the region. By country, most active issuers were K&H (KBC Group - whose market share reaches almost 50%), OTP, CA-IB (HVB group), CIB (Banca Intesa), Budapest Bank (GE) and Raffeisen Bank in Hungary, Ceska Sporitelna, CSOB and HVB in the Czech Republic and BPH (HVB group), Kredyet Bank, Citibank and Pekao in Poland. Whatever the country, banks clearly dominate issuances. The lack of transparency in these markets makes it difficult to accurately determine volumes issued in 2005. Among 2005 main issuances are worth mentioning in Hungary, we highlight the Triathlon, the K&H ‘Fixplus2’ (a FX product) and ‘Hozamfa’ (Ariane option), OTP’s ‘Alpha’ and ‘Prizma’ (Hybrid Rainbow), and CIB’s ‘Profitmix’ series, one being a Stellar and the other a Spanish Fly and commodities. In the Czech Republic and in Slovakia, Ariane and Asian calls were the norm. There was also appetite for hybrids (often associated to a Best Of Profile) as well as for commodity underlyings mostly traded through Spanish Fly or Comet Coupon structures. In Poland, the Asian Pyramid sold well, along with some CPPI funds and Athena.



PORTUGAL Volumes in 2005 are up 30% year on year, reaching €2.2bn, with the structured retail products business being still dominated by the fixed income segment. Activity actually was a little disappointing in 2004 and that was most likely due to unfavourable economic conditions combined to an already high level of household debt. Though economic conditions were not really different in 2005, volumes were boosted by the development of the ‘fund’ wrapper, what appeared as a novelty for the Portuguese investor, used to the traditional ‘Note’ products. Almost non existent in 2004, products packaged as funds now account for 20% of the products sold. Most active issuers in 2005 were Santander, Banco BPI and CGD. Banks and asset management firms (most being banks’ subsidiaries) control 90% of the structured products retail market, the remaining 10% being mostly tapped by insurance companies. There also were changes as regards pay-offs in 2005 with soaring demand for simple, straightforward growth pay-offs such as a participation in an Asian or Vanilla call and with the development of dispersion/relative performance play products. 2005 also featured the development of the Hybrid theme, mostly traded via the Best of Profile or Asian Call options, with growing interest in commodities and energy underlyings. This craze for more exotic underlyings should actually strengthen in 2006, since investors are expected to show, in addition to commodity assets, interest in emerging stock markets. IRELAND Most active issuers were Bank of Ireland, IIB, First Active and Allied Irish Bank. There was increased issuance on CPPI products linked the issuer's own actively managed funds such as Friends First Protected Investment Bond, New Ireland Protected Evergreen Fund and Eagle Star Protected Dynamic Fund. And there should be other insurers to follow in 2006 with their own CPPI products. Property indices linked products continued to be in demand, notably during the 1st half of 2005. Digital payoffs on equity indices as well as commodities linked product were also popular such as the Best of Profile on an hybrid basket issued by IIB. Like in many other European countries, we started to see less than 100% capital protected products as EUR rates remained low. The 15bn EUR of the Government-backed SSIA will be maturing from April 2006 to April 2007. No replacement product was announced by the Irish government so providers are all looking to offer replacement product. Opinion differs on how much will be reinvested but providers such as Bank of Ireland do not expect investors to spend their money all at once. Moreover, investors now have the saving habit and will continue to save.



GREECE, CYPRUS and MALTA The activity proved very dynamic in Greece in 2005. EFG Eurobank Ergasias remains the main issuer of structured products in the region in 2005. Cyprus and Malta continue to develop. Return profiles remain very dynamic in Greece, going against the trend featuring simpler profiles observed on the continent. Although some capital-at-risk structures were sold, the Greek individual investor shows interest in products offering full capital guarantee at maturity. They are still attracted by periodical coupons – guaranteed or conditional; thus a high number of Coupon Driver and Predator were sold in the region. Appetite for regular coupons – conditional and/or guaranteed – and for capital protection is as strong in Cyprus and Malta as in Greece. Since it benefits from a more advanced legislation, enabling the country to better benefit from the European regulations, Malta has no cause to be envious of its Greek counterpart in terms of sophistication and reactivity. The situation is slightly different in Cyprus where innovations on the Greek market are marketed with a few months’ lag. In line with the trend observed in 2004, Hedge funds used as underlyings of structured products are slowly being replaced by traditional mutual funds, traded via standard or Asian calls, CPPI or Best Of Profile. The upsurge in Greek equities recorded over the past months is likely to arouse more interest from investors in this type of underlyings. This should be quite favourable for the industry of structured products commercialised in Greece, given that most of them are sellers of volatility (from the investor’s standpoint) and that implied volatility prices on these equities is higher than for European blue chips. Neglected in 2004, commodity and energy underlyings gave birth to several structures in 2005 (use of oil, gold, copper, aluminium). Conversely, when it comes to stocks from emerging economies, only Asian ones arouse some interest. We observe a large extension of maturities, owing to difficult structuring conditions and the relative flexibility of Greek investors towards investment horizons, which is not the case elsewhere in Europe. Maturities therefore range from 1 to 12 years, the majority of them being in the 3-8 year range. As for Cyprus, maturities are much shorter – they do not exceed 6 years - and range between 5 and 10 years in Malta.



Where should the SRP business head up to in 2006? 2005 was another trying year for European products manufacturers, because of low levels of interest rates notably in continental Europe. It was all the harder since investors demanded capital protection, guaranteed returns, high participation rates in the underlyings’ performance, and proved quite inflexible regarding possible maturity extensions. Besides, as pay-offs are becoming simpler – leading to the use of more or less vanilla options, they worsened the already complex situation. Indeed, with this type of options, structuring is at a disadvantage when interest rates are low. Low volatility levels observed on equity markets were also a problem for structures whose investors are sellers of volatility. This gloomy picture of market parameters must not conceal the positive situation regarding fundamentals. The good progress of asset classes will further boost individual investments in financial products. Besides, since structured products make it possible to access all asset classes and to offer capital protection in part or in full, they will remain a key investment vehicle in this environment. In this section, we first explain our expectations both in terms of direction for most of the investable asset classes and for market parameters such as volatility, interest rates, and correlation and dispersion levels for main markets. Confronting this environment to what is currently available in the structured retail products business in terms of structures should help us determine adapted investments that can be proposed throughout 2006.

Another trying year on the pricing side, but a supportive fundamental newsflow



OUR DIRECTIONAL BETS FOR 2006

ASSET CLASS

EXPECTED MOVE

COMMENT

MATURE EQUITY MARKETS USA, Europe, Japan

Main equity markets are expected to benefit from strong global growth in 2006 (+4.0%), stirred by buoyant US and Asian economies. Stock indices will consequently continue to discount a strong earnings growth potential. And this adds to other positive factors: attractive valuations for stocks and more M&A activity to come in the next 12 months. Japanese stocks should experience the biggest rise as the domestic activity will benefit from a fully-fledged economy and a renewed corporate pricing power.

EMERGING EQUITY MARKETS China and India Eastern Europe and Latin America

Our strategists are even more bullish on emerging markets, notably Chinese and Indian stocks. China and India should experience economic growth rates significantly above those of mature economies, with GDP growth for China and India respectively expected to reach 9% and 8% in 2006. A more cautious stance is recommended on other emerging markets such as Eastern Europe and Latin America, as expected GDP growth rates will not be comparable with those of Asia. Though we expect most emerging markets going north in 2006, we would recommend avoiding Brazil as the GDP growth should be limited at 2.3% and as domestic earnings revisions are pointing in the wrong direction.

FIXED INCOME US T-Bonds

US T-bond prices should experience a slight rise with the monetary tightening policy coming to an end in the country and the prospect of a decelerating economic growth as early as 2007. This could actually lead to other temporary inversions in the US interest rates curve throughout 2006.

Sov. Bonds EUR, GBP, CHF

European government bond prices are expected to remain stable in 2006 as inflationary pressures should not materialise over the period. Moreover, liquidities should continue to pour into the world economy and keep long-term rates at reasonable levels: though the ECB has already started to tighten rates, further moves in 2006 should be limited by the expected strengthening of the euro versus the dollar.

FOREIGN EXCHANGE USD vs. main currencies

The continued monetary tightening in the US and the fiscal stimulus as regards repatriation of profits made abroad for US companies were two major catalysts for the greenback strength that will disappear in 2006. As there will be fewer forces to counterbalance the negative impact of too much consumer debt and external deficit, our economists expect the dollar to show weakness versus main currencies throughout the year.

INFLATION Inflation (USA/EU)

Core inflation remained under control in 2005 as companies have been able to absorb higher commodity and energy prices. Wage moderation in mature economies and the downward pressure on prices of industrial goods from increased global competition should continue to keep the core inflation rate at moderate levels.



ASSET CLASS

EXPECTED MOVE

COMMENT

COMMODITIES Base Metals

Base and precious metals have been very profitable asset classes over the past four years and prices are now high. (though not so high if inflation adjusted and compared with the record prices reached in the 70s-80s). However, given the abundance of liquidity and the strong GDP growth expected in the US and Asia alike in 2006, we would not bet on a momentum inversion in the coming months. However, as production facilities develop and better match demand, our economists warn against a weakening of the trend somewhere in 2006. Note that base metals do not all provide similar returns, with Nickel and Tin both turning in negative performances over 2005.

Gold

Key drivers for gold were most certainly inflation fears and liquidity abundance in 2005. Along with these two supportive factors, another trigger should materialise in 2006 and give some additional support to gold prices: the expected decline in the dollar.

ENERGY Oil

Oil prices should have fell back in 2006 as the crude oil market balance is expected improve significantly. US and European crude stocks are already far higher than last year. Nevertheless, as tensions revive in the Middle East, the perception of a probable supply disruption will keep oil prices at a premium.

Natural Gas

On average, gas prices in 2005 have roughly doubled when compared with the previous year. Fears of a potential gas shortage (notably in the US) will be a major catalyst for high volatility in 2006, notably during all the winter season with potential price variations as much as 50% around current prices. All in all, our specialists nevertheless do not expect the upward momentum on gas prices to exist all along 2006, with an average gas price expected to be similar to that observed in 2005.

REAL ESTATE Real Estate Indices (USA, Europe)

The real estate stocks momentum kept accelerating until 2005 but has deteriorated in recent months. The rise in short-term rates is a sound explanation to this change. The sector will undoubtedly remain very sensitive to any change in the yield curve. The good news is that our economists do not expect significant shifts in the curve this year.



Pricing Environment Volatility For most of the past year, implied volatility on equities traded at low levels from a historical standpoint, further down compared with the previous year. Naturally, this had an impact on the industry, further supporting options for which the investor is a buyer of volatility, and inversely penalising those for which the investor is a seller of volatility. The graph below shows that current volatility levels trade in the lower part of their historical range of the last 4 years for most equity indices. Note that the Nikkei tends to behave differently, its 3Y implied volatility trading at a higher level: the rise in implied volatility has actually been recorded in the last two months, with the momentum gathering pace, the Nikkei 225 showing a 9% increase each month. 3Y implied volatility – current levels vs. historical highs–lows in the last 4 years

10

15

20

25

30

35

S&P500 FTSE100 NIKKEI225 SMI EUROSTOXX50

3Y implied volatility at 12/31/2005

Source: BNP Paribas Though the current newsflow may push volatility levels higher in the coming weeks – a more aggressive UN stance against Iran may spur oil prices significantly higher, raising concern as to the sustainability of a strong economic momentum in 2006 – on a longer term approach, there is no valuable reason to anticipate a return to a high volatility regime as it was the case in the early 2000’s. Stocks still trade at reasonable prices, interest rates are not expected to show any significant move in 2006 and corporate balance sheets remain sane, with limited debt. Note that most companies have again been able to meet market expectations in terms of results for Q4. Interest rates European swap rates (EUR, GBP and CHF) appear almost unchanged in 2005. However, a closer look reveals that interest rates tended to be lower throughout the year, rendering the structuring business very challenging, whereas in the US, swap rates have been rising throughout the year, though to a limited extent. The graph below clearly shows that current funding conditions remain unfavourable on historical standards in Europe. In the US, the interest rate hike

Implied volatility levels went further down in 2005 on equities

A reversion to a high volatility regime is unlikely in 2006

Swap rates remain almost unchanged year on year



observed during the year results in a much more comfortable outcome for structuring at the beginning of 2006. Note that, on absolute levels, the UK still benefits from the best environment. 3Y IR swap rates – current levels vs. historical highs–lows in the last 4 years

0

1

2

3

4

5

6

7

8

EUR GBP USD CHF

IR s

wap

rate

(%)

Source: BNP Paribas We expect short-term rates to rise in the eurozone, the UK and Switzerland alike in 2006 as both the improving economic momentum and inflation concerns are mounting all around Europe. This should mainly impact shorter maturities with the 10Y interest rate expected to remain unchanged in all cases. The funding environment is consequently expected to get better in 2006 in Europe and mostly support more standard options such as vanilla and Asian calls and comfort both the capital protection and guaranteed coupons features. Note that the United Kingdom will continue to benefit from the best funding environment in 2006. Our economists anticipate a different trend in the US, with a slight deterioration of the funding environment over the period. The inverse move expected between the US and the European swap rates will make it easier to finance US underlyings with EUR, GBP or CHF denominated structures and lead to more US denominated equity underlyings for options sold to European investors - please refer to table on next page for details.

European short-term interest rates should show a gentle rise in 2006.



EXPECTED CHANGES IN INTEREST RATES

COMMENT

EUR

2.5

2.7

2.9

3.1

3.3

3.5

3.7

2Y maturity 5Y maturity 10Y maturity

swap

rate

s (in

%)

end 2005

end 2006

EUR swap rates – shorter maturities should experience a rise in interest rates with expected tightenings from the ECB. However, the tightening cycle should be curtailed in the second half of 2006 due to a less favourable external growth environment and the forecast appreciation of the euro. Funding conditions should consequently improve in 2006 for EUR denominated products, for most maturities.

USD

2.5

3

3.5

4

4.5

5

2Y maturity 5Y maturity 10Y maturity

swap

rate

s (in

%)

end 2005

end 2006

USD swap rates – our economists expect the US interest rate curve to experience a downward parallel shift in 2006, thus keeping its current flattish shape. Our economists actually consider that the US economic momentum should decelerate in the second part of the year and that the Federal Reserve will thus have to revert back to a more accommodative stance as the year goes by.

GBP

4

4.2

4.4

4.6

4.8

5

5.2

3M maturity 10Y maturity

swap

rate

s (in

%)

end 2005

end 2006

GBP swap rates – An improving economic newsflow and higher energy and commodity prices have already raised inflation concerns among BoE’s officials. Our economists thus consider that the next move on the benchmark rates is skewed on the upside. Note that the impact on the yield curve is expected to be limited, notably for longer maturities.

CHF

1

1.2

1.4

1.6

1.8

2

2.2

2.4

3M maturity 10Y maturity

swap

rate

s (in

%)

end 2005

end 2006

CHF swap rates – As the growth momentum regains and broadens to domestic consumption and investment, SNB’s officials have already made it clear that a tighter monetary policy is in the cards. As for the UK, future moves in the benchmark rates should mostly impact the shorter part of the yield curve.



Correlation and dispersion

Historical correlation among main indices and implied correlation among Eurostoxx 50 bluechips

Historical 780 days correlation of the Eurostoxx 50 with...

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Dec-03

Feb-04

Apr-04

Jun-0

4

Aug-04

Oct-04

Dec-04

Feb-05

Apr-05

Jun-0

5

Aug-05

Oct-05

Dec-05

Cor

rela

tion

Leve

l

S&P 500 COMPOSITE - PRICE INDEX NIKKEI 225 STOCK AVERAGE - PRICE INDEX

SWISS MARKET - PRICE INDEX FTSE 100 - PRICE INDEX

HANG SENG - PRICE INDEX

2Y implied and realized correlations among European bluechips

40%

45%

50%

55%

60%

65%

70%

75%

Jan-0

2

Apr-02

Jul-0

2

Oct-02

Jan-0

3

Apr-03

Jul-0

3

Oct-03

Jan-0

4

Apr-04

Jul-0

4

Oct-04

Jan-0

5

Apr-05

Jul-0

5

Oct-05

Implied Correl. Realized Correl.

Source: BNP Paribas Correlation between Western indices has been heading down in the last 2 years but the momentum clearly strengthened in the last 6 months. This is notably true for correlation levels between the Eurostoxx 50 and the S&P 500. A similar phenomenon is observed for correlation among stocks: the right-hand graph shows that correlation among the Eurostoxx50 components is on a falling trend; with realised correlation currently trading at its lowest level in the last 4 years. The two most obvious explanations we see to this downward trend are 1/that stock markets have been rising over the period what traditionally leads to greater dispersion levels among stocks and 2/that issuances of structured products based on stock baskets have up to now almost always been sellers of correlation, thus pushing this parameter further down.0 Forecasting the evolution of the correlation between stocks in the next months is today very difficult: our bullish scenario assumes that dispersion will remain high. Nonetheless, the development of structures for which structurers are buyers of correlation (outperformance products between assets) can change the direction of the trend depending on the volumes traded. However, in terms of correlation between western indices and Asian main indices (Hang Seng, Nikkei 225), correlation levels have been stable for several months, at around 0.5. They still represent an efficient diversification tool in comparison with European and US indices.

The decline in correlation has gathered pace in the last 6 months



What should trade in 2006?

• The strong momentum on most asset classes will fuel demand for straitghtforward, growth structures.

• Novelty, diversification, volatility and stunning performances that commodity and energy products are able to provide guarantee them another year of popularity.

• Boldness in underlying selection may come with demand for protected capital.

• The search for higher returns may compromise further development as to guaranteed coupons.

• Outperformance and dispersion structures should be part of preferred products in 2006 thanks to their ability to be unlinked to the market bias and match most banks’ trading interests.

The healthy performance of the various asset classes observed over recent years will further fuel demand for growth structures in 2006. The use of underlyings other than the usual equity and interest rate markets should also gain market share thanks to numerous effects: novelty, diversification, and the ability to outperform traditional assets. We even expect some under- and unexplored assets such as electricity and soft commodities to catch investors' attention this year. Since conditional coupon structures - such as Comet, Ariane, Range Accrual, and Wedding Cake - are all sellers of volatility, they should more and more use volatile underlyings, such as equities from emerging markets, commodities or energy. Pay-off profiles have become much simpler, and this trend is very likely to persist in 2006. The structured products market in Europe is gaining in maturity, since investors are looking for products that can reap profit from a simple directional momentum-type scenario, in a similar fashion to what has already been observed on the UK markets for several years. The so-called growth profiles should therefore remain the dominant theme. Capital guarantee will remain a highly demanded feature. Although investors will take risks towards equities in 2006, they will not rule out a probable reversal all the more since equity markets have sharply increased over the past 4 years. The resort to more exotic assets such as commodities or energy will also be framed by security given the relative novelty of this type of underlyings, their high volatility, and the lack of knowledge towards them. Structures providing guaranteed coupons the first years have increased in number in 2005; only Belgium showed tangible signs of a trend reversal. This phenomenon observed in Belgium might serve as a forewarning of a more general reversal in 2006, since the country was the first to use guaranteed coupons massively. Besides, two arguments in favour of a decline in this feature have been put forward: 1/financing conditions remain difficult, in continental Europe at least: investors therefore have to choose between a guaranteed return and an option with a high return probability. 2/the bullish momentum observed on main assets pleads for immediate exposure rather than for preset returns in the short run – where visibility is naturally much greater – and with an exposure to the underlying delayed in time.



Lastly, outperformance and dispersion structures are likely to be part of the preferred products in 2006 thanks to their original features and their ability to be unlinked to the market bias. Finally, offering trading rooms the opportunity to counterbalance positions buyer of dispersion – coming from the massive marketing of options on baskets of assets such as Worst Of, Comet, Venus and Ariane, they should further display aggressive prices, making this type of structures all the more attractive.



3 suggested plays GROWTH PLAY Structure’s features Capital protection: Hard (100%) Option’s type: Rainbow Underlying: hybrid basket (Copper, Gold, Nikkei 225) Maturity: 5 years Expected gearing: 100% Currency: EUR Other: quanto Rationale - these 3 assets are expected to show strong rises in 2006. - low forward on the Nikkei, backwardation effect on copper make the

structure attractive from a pricing standpoint. - diversification effect as these assets present weak correlation levels. - quanto play as we expect the US dollar to weaken versus main currencies

in 2006. INCOME PLAY Structure’s features Capital protection: Soft (-25%) Option’s type: Athena Express Underlying: OIL Continuous deactivating barrier: 20% Rebate: 6% annualised DIP barrier: -25% Maturity: 3 years Currency: EUR (quanto) Rationale - Oil spikes is a likely outcome as tensions revive in the Middle-East. - The OPEP may now act so as to keep barrels prices above the $50

threshold, what represents a theoretical maximum 17% drop on current prices (note that the down and in barrier is set at -25%).

- To touch the upper barrier is a realistic target given the underlying’s volatility. - Short term maturity allows to an earlier switch to a new market’s scenario.



RELATIVE PERFORMANCE Structure’s features Capital protection: Hard (100%) Underlying: China versus Brazil (HSCEI vs. Brazil Bovespa) Annual Coupon: 7% provided the HSCEI/Brazil Bovespa performance spread remains positive from inception date – Subsequent coupons are not paid, should the HSCEI lose 20% or more at any time over the product’s life. Maturity: 3Y Other: quanto Currency: EUR Rationale - Strong economic momentum expected in Asia, sluggish GDP growth in

Brazil - Short term maturity allows to an earlier switch to a new market’s scenario - Long Short type, thus low sensitivity to forward prices



Glossary – types of options

We summarise below the most common structured products currently marketed to retail customers. This list is subject to change in future publications, to reflect shifting circumstances. In the Appendix, readers will find a table classifying options according to whether they buy or sell volatility and also according to correlation (from the investor’s standpoint) and the average sensitivity to these two parameters.

Capital-protected products Altiplano Refer to Comet.

Alterna A product that on maturity pays the maximum return between a coupon and the worst-performing asset in a basket. The underlying is typically a basket of diversified stocks.

Annapurna A product that on maturity pays the maximum return between a variable rate coupon and the performance of a basket. The later the component basket assets cross a lower barrier, the bigger the share of the performance and the coupon. The underlying is typically a basket of diversified stocks.

Ariane On maturity this product pays a coupon whose value is a function of the number of basket assets crossing a lower barrier during a given period. The higher the number of assets crossing the lower barrier, the more the coupon value diminishes. The underlying is typically a basket of diversified equities.

Variants

Ariane Range: the coupon’s value is a function of the number of basket assets crossing either a lower or a higher barrier.

Two chances: Ariane Range with 1 additional range, wider, but that gives right to a smaller coupon.

Wedding Cake: with more than 1 additional wider ranges. The wider the range, the lower the coupon value.

Arlequin Pays at maturity the performance of an out of the money vanilla call.

Asian Call A product that on maturity pays out the performance of the underlying. This is calculated as the arithmetic mean of the performance recorded at different dates in the option’s life. There is no typical underlying for this type of option.

Variants



Asian Best of: only the better of the two most recent performances is taken into account at the different dates to calculate the average.

Super Asian: only the positive performances by the underlying are taken into account to calculate the average at the different dates.

Super Super Asian: the performances at the different dates are only taken into account if they are higher than the preceding performances.

Asian Call ‘Italian Style’: the reference points used to calculate performance become more widely spaced out over the life of the option.

Asian Call with Cap: an Asian Call that is capped to limit the option's upside.

Asian Pyramid: an Asian Call that pays out at maturity the best performance of those recorded throughout the option’s life on the different observation dates.

Bear Spread On maturity this product pays an arbitrarily capped portion of the underlying’s negative performance as registered when the investment matures. A combination of plain vanilla options usually based on a single underlying.

Variants

Asian Bear Spread: Vanilla options are replaced by Asian options.

Best of On maturity this product delivers the maximum return of either a fixed coupon or the performance of an option. There is no standard underlying for this type of option.

Best of Profile - Profiler Delivers at maturity the best Asian performance among several baskets embedding identical assets but with different weighting so as to give baskets more aggressive or defensive profiles. Underlyings usually combine stock indices, fund baskets or different asset classes.

Binary Call Refer to Digital Call variants

Binary Worst Of Coupon Please refer to Everest variants.

Blossom On maturity this product pays out a share in the performance of a selected underlying asset. The proportion of the underlying’s performance increases over time so long as the underlying stays within fixed upper and lower barriers for a given period. The underlying is typically a single asset.

Bull Spread This product pays an arbitrarily capped portion of the underlying’s positive performance on maturity. A combination of plain vanilla options usually based on a single underlying.

Variants

Asian Bull Spread: a Bull Spread consisting of Asian calls.

Cappuccino



Pays at maturity the average of the underlying assets individual performances. Underlying assets performances are arbitrarily set, should they present a positive return over the period. If not the case, it is the real periodic performance that is taken into account. This option is usually based on a basket of stocks.

Variants

Predator: Cappuccino for which the underlying’s performance is set as soon as the latter becomes positive.

Captibasket On maturity pays out the performance of a basket of assets. An upper barrier is applied to each of these assets individually over the life of the option. The final quoted price applicable to the assets exceeding the upper barrier is the same as the upper barrier threshold. The underlying is typically a basket of diversified stocks.

Captibonus Works like a Captibasket, the difference being that each asset is the underlying of an up-and-out call with a rebate. The underlying is typically a basket of stocks.

Climber Refer to Ladder variants.

Cliquet Call On maturity delivers the aggregate plain vanilla performances in each period of an underlying. There is no standard underlying for this type of structure.

Variants

Cliquet with Local Cap: performance in each period is arbitrarily limited on the upside.

Cliquet with Local Cap and Floor: performance in each period is arbitrarily limited on both the upside and the downside.

Digital Cliquet: the performances in each period correspond to different pre-determined amounts according to whether the underlying(s) rise(s) or fall(s) in the period.

Cliquet with local individual cap: the periodic performance of each underlying asset in a basket is arbitrarily limited on both the upside and the downside.

Cliquet with local cap on best periodic performances: only the X best performances are limited on the upside.

Variable Local Cap: capped and floored cliquet with any negative periodic performances retained used to raise the level of the cap for the following period. There is no typical underlying for this option.

Dragster: Capped cliquet for which the performance retained at maturity corresponds to the highest accumulation of the periodic performances. There is no typical underlying for this option.

Cliquet Lock-In: A ladder for which the underlying’s performance is calculated as for a cliquet. There is no typical underlying for this option.



Twister: on maturity pays a coupon minus the sum of the negative performances of the underlying asset over the different periods of the option’s life. The underlying can either be an index or a single stock.

Reverse Twister: pays a coupon minus the sum of the positive performances of the underlying in the different periods.

Napoleon: pays a coupon in each period diminished by the worst performance of the underlying in different sub-periods. The underlying is typically a single index. Coupons can be paid at each period-end or aggregated and paid at maturity.

Galaxy: on maturity pays out the lowest absolute performance among assets within a basket. The underlying is typically a basket of diversified stocks.

Variants

Galaxy Coupon: Galaxy that pays at the end of each period a coupon corresponding to the lowest absolute performance among assets recorded from inception.

Comet - Altiplano On maturity this product pays a coupon or the performance of an underlying basket, depending on whether or not one or more of the basket assets crosses a lower barrier. The underlying is typically a basket of diversified stocks.

Convergence Pays a coupon in each period, reduced by the difference between the best and the poorest performance of the assets contained in a basket over the period. The underlying is typically a basket of indices.

Coupon Comet Pays a coupon in each period provided none of the basket assets crosses a lower barrier during the period. However, a low-value coupon can nevertheless be paid if the barrier is breached. The underlying is typically a basket of diversified equities.

Variants

Coupon Comet Restrike: the initial price of the stock showing the greatest fall at the end of the period is updated to the latest price, provided at least one asset breaches the lower barrier.

Coupon Comet Snowball: unpaid coupons at the end of each period are retained, aggregated and paid once payment conditions are fulfilled.

Coupon Comet Double Chance: a Coupon Comet Snowball in which unpaid coupons are only paid on maturity provided satisfactory conditions for a payout are fulfilled.

Yeti: Coupon Comet combining the effects of a Restrike and a Snowball.

Coupon Driver Refer to Cliquet variants



Digital Call On maturity this product pays a coupon provided that during the life of the option the underlying crosses a barrier determined at the start of the operation. This option usually has a single underlying.

Variants

Binary Call: the coupon is only paid if the underlying has crossed the barrier when the option matures.

Dragster Refer to Cliquet variants

Driver At maturity, pays out the average of underlying assets individual performances, with the X best performances recorded among the assets arbitrarily capped. The underlying is typically a stock basket.

Variants

Coupon Driver: pays out on a periodic basis the average of underlying assets individual performances since inception, with the X best performances recorded among the assets arbitrarily capped.

Equinox On maturity, pays a coupon whose value is proportional to the number of assets in a basket which, over the life of the option, have delivered a return exceeding the risk-free rate. The underlying is typically represented by a single regional index.

Everest - Worst of On maturity, pays a coupon augmented by the worst performance of the basket’s various assets. The underlying is typically a basket of diversified equities.

Variants

Worst of Floored Coupon - Sherpa: pays a coupon at the end of each period ranging from, at least, the value of the prior period's coupon and, at most, a share in the worst performing of the basket's assets. The first coupon's value is set arbitrarily.

Everest Binary – Worst Of Binary: pays a coupon at maturity provided all the basket's assets trade higher than a price limit set before the transaction.

Everest Binary Coupon – Worst of Coupon Binary: works like an Everest Binary but with a periodic coupon payment.

Extreme Spread On maturity pays the holder the performance of a basket whose initial price is the combined averages of each underlying’s highs during an initial period and its lows in a subsequent period. The initial period is usually at the start, and the subsequent period at the end of the contract. The underlying is typically a basket of indices.

Galaxy Refer to Cliquet Call variants



Galaxy Coupon Refer to Cliquet Call variants Gap Note Pays, in addition to guaranteed coupons, a high coupon provided the underlying falls by 20% within 1 day. The underlying is usually an equity index. Himalaya Pays out the performance of a basket on maturity. The performance is the arithmetic mean of the single best or several best performances of the basket’s component assets at the end of each period. The selected best-performing asset or assets are permanently removed from the basket at the end of each period. The underlying is usually a basket of sector indices or diversified shares.

Variants

Himalaya Cumulative: Asian as opposed to plain vanilla performances are used for calculation purposes.

Himalaya with Cap: the performances used for calculation purposes are individually capped.

Ladder On maturity delivers the higher of the two returns between an underlying’s performance at the maturity date and the value of the highest barrier exceeded by the underlying during the option’s life. Underlyings are typically baskets of regional stock indices.

Variants

Pyramid Ladder: the underlying asset(s) performance(s) is averaged similarly to an Asian pay-off.

Climber: Ladder with barriers applied to the underlying basket’s components individually. The option’s performance is generally capped at the level of the highest barrier.

Lookback On maturity pays out the best performance of the underlying recorded during the life of the option. The option is usually based on a single underlying.

Napoleon Refer to Cliquet Call variants Nova At the end of each period, it pays a coupon that corresponds to the underlying’s annualised performances since the beginning of the investment period. The periodic coupon is floored to 0. The underlying is typically a basket of stocks or indices.

Podium Pays a coupon in each period, provided a sufficient number of basket assets are trading above their initial prices at the end of the period. The number of assets that must trade above their initial value increases from one period to the next, as does the coupon value. Coupons payable at different periods are aggregated and paid together on maturity. The underlying is typically a basket of diversified stocks.

Variants



Podium Outperformance: works like a Podium except that the periodic coupon is paid provided there is a sufficient number of underlying assets outperforming a given benchmark over the period. The main marketing argument is that the payoff can be positive in a falling market. Predator Refer to Cliquet variants

Profiler Refer to Best of Profile

Rainbow On maturity pays out the performance of a basket whose best-performing assets at maturity are overweighted. The underlying is typically a basket of sector or regional indices.

Variants

Asian Rainbow: the Asian as opposed to plain vanilla performances of the underlyings are taken for calculation purposes.

Range Accrual On maturity pays a coupon proportional to the number of days that the underlying remains in a predetermined zone. The underlying is typically a single asset.

Samourai On maturity pays out the performance of a basket, with any assets having fallen below a predetermined level at any time during the option’s life locked in at that level. Otherwise, each asset’s performance is registered at its actual value, the latter nevertheless being floored and capped.

Sherpa Refer to Everest variants Spanish Fly At maturity, pays the best performance between a fixed coupon and a participation in the worst-performing underlying of a basket, on the basis of a positive evolution. If the evolution turns out to be negative, the investor is at maturity redeemed the difference between the coupon's value and the worst negative performance recorded among the underlyings. Typically, the underlying used is a basket of stocks or hybrid.

Sprint At maturity pays out a share in the performance of a basket provided a minimum number of component assets in the basket fails to exceed an upper barrier during the product’s life. Otherwise, a coupon is paid on maturity. The underlying is typically a basket of indices.

Starlight The option is eliminated if an upper barrier is exceeded at the end of each period by any asset in the underlying basket, with the investor receiving a coupon equivalent in value to the barrier, the latter being proportional to the number of periods expired. Otherwise, the investor receives the performance of a plain vanilla call option at maturity. The underlying is typically a basket of indices.



Variants

Asian Starlight: the average and not the plain vanilla performance of the underlying applies.

Stellar At the end of each period it pays the yield to date of a vanilla option on a basket of assets capped individually. The underlying is typically a basket of stocks.

Straddle On maturity pays out the absolute value of the underlying’s performance as at the maturity date. A combination of plain vanilla options usually based on a single underlying.

Variants

Strangle: the absolute value of the underlying’s performance is scaled back by a predetermined amount.

Stretch Pays out a periodic fixed coupon less the underlying’s best absolute performance during the different sub-periods. The underlying is typically an index.

Super Call On maturity pays either a coupon or the return of an underlying selected on the basis of whether an upper barrier is crossed or not during the life of an option. The barrier’s level and coupon increase with time, provided the barrier is not exceeded. The underlying is typically an index or a single stock.

Stellar At the end of each period, it pays out the yield from the beginning of the investment period to the observation date of a vanilla call option on a basket of individually capped assets. The underlying is usually a basket of stocks.

Tatihou Pays at maturity the average performance among the n best performing underlyings assets within a basket.

Titan On maturity pays out the performance of an underlying over a period multiplied by the best performance of this underlying over predetermined periods. The underlying is typically a basket of diversified stocks.

Trampoline On maturity pays out a coupon after deducting the aggregate negative performance of the different components of the basket over the product’s life. The underlying is typically a basket of diversified stocks.

Triathlon Pays the best Asian performance among 3 portfolios. Each portfolio is divided into units, the number of which corresponds to the number of observation dates. At each observation date, the best-performing unit for each portfolio is permanently removed and its performance since inception retained to compute the average performance of the portfolio. At maturity Triathlon pays the best performance among the 3 portfolios. Portfolios are usually a combination of



distinct asset classes, with each asset class to be found in each portfolio but in varying proportions.

Twister Please refer to Cliquet Call variants

Two Chances Refer to Ariane Range Up and Out Call On maturity pays out the performance of a call option provided the underlying never crosses a predetermined barrier during the life of the option. This type of option usually has a single underlying.

Vanilla Call with Individual Caps A vanilla call based on a basket of assets whose individual performance is capped. The underlying is typically a basket of shares.

Variable Local Cap Refer to Cliquet variants Volatility Gainer On maturity pays a coupon less the sum of the absolute values of the underlying’s performance over the different periods of the option’s life. The underlying is typically a single index.

Wedding Cake Refer to Ariane variants Worst Of Refer to Everest Worst Of Binary Refer to Everest variants

Worst of Floored Coupon Refer to Everest variants

Yeti Refer to Coupon Comet variants Zero Cost Collar A combination of plain vanilla options, with the investor financing either the purchase of a call by selling a put or the purchase of a put by selling a call. The exercise prices of the two options are calculated so that the cost of the structure is zero. The underlying is typically a single asset.



Non-capital-guaranteed products Airbag Like an Athena structure to which is added a Call Spread structured so that at maturity the investor earns money even if the underlying records a loss over the investment period. The initial capital is only at risk if the underlying falls below a certain minimum under its initial value. The underlying is typically a single asset.

Athena Like a Reverse Convertible but has one additional characteristic: the contract expires prematurely if the underlying produces a minimum positive performance between the start of the contract and the end of any period. In these cases, the owner of the structure is paid a compensatory coupon proportional to the number of expired periods. The embedded Put option is traditionally of down and in type. There is no typical underlying for this type of structure.

Variants

Athena Express: includes another early redemption trigger materialised by an upward continuous barrier. Should this barrier be crossed by the underlying asset, the product terminates and the compensatory coupon is paid either instantaneously or at the end of the period.

Bonus Certificate – Certi + Reverse Convertible based on a down-and-in put that at maturity pays the maximum between a predetermined coupon and the performance of the underlying provided the put barrier has never been breached. Otherwise, the investor is paid the stock performance.

Certi + Refer to Bonus Certificate Kilimanjaro Pays a coupon in each period and on maturity pays out the performance of a basket whose assets are selected by progressively eliminating the worst-performing assets from the basket over the life of the basket. An equivalent number of best-performing assets is also discarded on maturity. The remaining assets are used to calculate the basket’s performance. The underlying is typically a basket of diversified stocks.

Reverse Convertible The investor sells a plain vanilla put option and therefore receives a premium in the form of a coupon. The coupon can be paid in several instalments or in full on maturity. This structure usually has a single underlying.

Venus Similar to the Athena Option but based on a basket of stocks.

Miscellaneous Callable The option seller has the right to cancel the option during its lifetime subject to paying the holder compensation. The cancellation dates and compensation are predetermined. This feature can theoretically be applied to any type of option.



CPPI CPPI stands for Constant Proportion Portfolio Insurance. It is a fund that gathers risky assets (called ‘underlying’) and risk-free assets (called ‘reserve account’). The principle consists of increasing the proportion of risky assets in the portfolio when the portfolio value moves away from the floor (floor = minimum NAV allowed) and, conversely, reducing this proportion when the portfolio value moves toward the floor. (For further explanation on CPPI, please refer to the January 2003 issue ‘Structured Products’ – ‘CPPI Guidelines’).

A variant exists:

CPPI Lookback: the floor value grows as the fund’s NAV increases.

Hybrids Derivatives based on distinct asset classes, such as interest rates, currencies, gold or commodity prices and inflation, along with equities. Please refer to the SRPs issue of October 2003 – ‘What about hybrid options?’ for an exhaustive list of existing structures.

Quanto Pays out the performance of an underlying in a different currency denomination from that of the amount reverting to the investor. This feature is applicable to every type of option.

ODB ODB stands for Option on Dynamic Basket. The underlying dynamic basket works as a CPPI, the difference being that the basket is never fully invested in risk free assets, whatever its NAV. (For further explanation on ODB, please refer to the January 2003 issue ‘Structured Products’ – ‘CPPI Guidelines’).

Putable The option buyer has the right to cancel the option during its lifetime provided pre-determined conditions have been fulfilled. This feature can theoretically be applied to any type of option.



Appendix Sensitivity to volatility and correlation of existing structures (in alphabetical order – investor standpoint) ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ Volatility ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ Correlation ⎯⎯⎯⎯⎯⎯⎯⎯⎯ Buyer/seller Degree of sensitivity Buyer/seller Degree of sensitivity

Airbag Seller High – – Alterna Buyer Weak Buyer High Annapurna Seller Medium Buyer High Ariane Seller High Buyer High Ariane Range Seller High – – Arlequin Buyer Medium - - Arlequin Lookback Buyer High - - Asian Call Buyer Medium Buyer Medium Asian Best of Buyer High Buyer Weak Asian Pyramid Buyer Medium Buyer Medium Super Asian Buyer Medium Buyer Medium Super Super Asian Buyer High Buyer Medium Asian Call ‘Italian Style’ Buyer Strong with short–term vol.

decreases thereafter Buyer Strong with short–term vol.

decreases thereafter Asian Call with Cap Seller Medium Buyer Medium Athena Seller Medium – – Bear Spread – – – – Asian Bear Spread – – – – Best Of Depends on type of option Depends on type of option Depends on type of option Depends on type of option Best Of Profile Buyer Medium Can vary across asset pairs Weak Binary Call Depends on the strike Weak for ATM strike - - Blossom Buyer Weak – – Bonus Certificate Seller Medium to High - - Bull Spread – – – – Asian Bull Spread – – – – Callable Seller Weak – – Vanilla Call With Individual Caps Seller Medium Buyer Medium Cappuccino Seller Medium Buyer Medium Captibasket Buyer if barrier is high Weak Buyer Medium Captibonus Buyer if barrier is high Weak Buyer Medium Climber Buyer Medium Buyer Weak Cliquet Call Buyer Medium Buyer Medium Cliquet Lock-In Buyer Weak – – Cliquet with local cap Seller Medium – – Cliquet with local cap and floor – – – – Digital Cliquet Seller Medium – – Cliquet with local individual cap Seller Medium Buyer Medium Cliquet with local cap on best perf. Seller Medium Buyer Medium Comet Seller Medium Buyer High Convergence Seller Weak Buyer High Coupon Comet Seller High Buyer Medium Coupon Comet Restrike Seller High Buyer Medium Coupon Comet Snowball Seller High Buyer High Coupon Comet Double Chance Seller High Buyer High Coupon Driver Buyer Weak Buyer Medium Digital Call Buyer High – – Dragster Seller Weak Buyer Medium Driver Buyer Weak Buyer High Binary – – – – Equinox Seller Weak Buyer High Everest Seller Medium Buyer High Everest Binary Coupon Seller Depends on strike Buyer High Everest Binary Seller Depends on strike Buyer High Extreme Spread Buyer High Buyer Medium Galaxy Buyer Weak Buyer Medium Galaxy Coupon Buyer Medium Buyer Medium Gap Note - - - - Himalaya Buyer Weak Buyer Medium Himalaya Cumulative Buyer Weak Buyer Medium Himalaya with Cap Buyer Weak Buyer Medium



Sensitivity to volatility and correlation of existing structures (in alphabetical order – investor standpoint) ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ Volatility ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯ Correlation ⎯⎯⎯⎯⎯⎯⎯⎯⎯ Buyer/seller Degree of sensitivity Buyer/seller Degree of sensitivity

Standard Hybrid Buyer High – – K2 Seller High Buyer High Kilimanjaro Seller High Buyer High Captibasket Buyer High Buyer High Lookback Buyer High – – Napoleon Seller Weak – – Nawak Seller High Buyer Medium Nova Buyer Weak Buyer Weak Up & Out Call Seller High – – Ladder Buyer High Buyer Medium Podium Seller Weak Buyer High Podium Outperformance Seller Medium Buyer High Predator Seller Weak Buyer Medium Pyramid Ladder Buyer Medium Buyer Weak Quanto Buyer High – – Rainbow Buyer Medium Buyer Weak Rainbow Asian Buyer Medium Buyer Weak Range Accrual Seller High – – Reverse Convertible Seller Medium – – Samourai Seller Medium Buyer Medium Sprint Seller High – – Starlight Seller Weak – – Asian Starlight Seller Medium – – Stellar Seller Weak Buyer Medium Straddle Buyer High – – Strangle Buyer High – – Stretch Seller High – – Super Call Seller High – – Titan Buyer High Buyer High Trampoline Seller High Buyer High Triathlon Buyer Medium Can vary across asset pairs Weak Twister Seller High – – Two Chances Selller High Buyer High Reverse Twister Seller High – – Sale of Down and In Put Seller High – – Spanish Fly on WO Basket Seller Medium Buyer High Variable Local Cap Seller Weak Buyer Weak Venus Seller Medium Buyer High Volatility Gainer Seller High – – Wedding Cake Seller High - - Worst Of Floored Coupon Seller High Buyer High Yeti Seller High Buyer High Zero Cost Collar – – – –

Source – BNP Paribas



BNP Paribas is incorporated in France with Limited Liability. Registered Office 16 boulevard des Italiens, 75009 Paris. BNP Paribas London Branch, 10 Harewood Avenue, London NW1 6AA is authorised by CECEI & AMF and the Financial Services Authority, and is regulated by the Financial Services Authority for the conduct of its investment business in the United Kingdom. BNP Paribas London Branch is registered in England and Wales under No. FC13447. Registered Office: 10 Harewood Avenue, London NW1 6AA. Tel: +44 (0)20 7595 2000 Fax: +44 (0)20 7595 2555 www.bnpparibas.com

In accordance with US regulations, the analyst(s) named in this report certifies that 1) all of the views expressed herein accurately reflect the personal views of the analyst(s) with regard to any and all of the content, securities and issuers and 2) no part of the compensation of the analyst(s) was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst(s) in this report. It is a BNP Paribas policy that analysts are prohibited from trading in any of the stocks in the sector that they cover. THIS PUBLICATION IS NOT INTENDED FOR PRIVATE CUSTOMERS AS DEFINED IN THE FSA RULES AND SHOULD NOT BE PASSED ON TO ANY SUCH PERSON. The material in this report was produced by a BNP Paribas Group Company. It will have been approved for publication and distribution in the United Kingdom by BNP Paribas London Branch, a branch of BNP Paribas SA whose head office is in Paris, France. BNP Paribas London Branch is regulated by the Financial Services Authority ("FSA") for the conduct of its designated investment business in the United Kingdom. BNP Paribas SA, a limited company, is registered as a bank with the “Comité des Etablissements de Crédit et des Entreprises d’Investissement” (“CECEI”) and is regulated by the “Autorité des Marchés Financiers” (“AMF”) for the conduct of its designated investment business in France. BNP Paribas Securities Corp. in the United States accepts responsibility for the contents of this report in circumstances where the report has been distributed by BNP Paribas Securities Corp. direct to U.S. recipients. The information and opinions contained in this report have been obtained from public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate or complete and it should not be relied upon as such. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, and are subject to change without notice. This report is not, and should not be construed as, an offer document or an offer or solicitation to buy or sell any investments. Any reference to past performance should not be taken as an indication of future performance. No BNP Paribas Group Company accepts any liability whatsoever for any direct or consequential loss arising from any use of material contained in this report. This report is confidential and is submitted to selected recipients only. It may not be reproduced (in whole or in part) to any other person. A BNP Paribas Group Company and/or persons connected with it may effect or have effected a transaction for their own account in the investments referred to in the material contained in this report or any related investment before the material is published to any BNP Paribas Group Company's customers. On the date of this report a BNP Paribas Group Company, persons connected with it and their respective directors and/or representatives and/or employees may have a long or short position in any of the investments mentioned in this report and may purchase and/or sell the investments at any time in the open market or otherwise, in each case either as principal or as agent. Additionally, a BNP Paribas Group Company within the previous twelve months may have acted as an investment banker or may have provided significant advice or investment services to the companies or in relation to the investment(s) mentioned in this report. This report is prepared for professional investors and is not intended for Private Customers and should not be passed on to any such persons. For the purpose of distribution in the United States this report is only intended for persons which can be defined as 'Major Institutional Investors' under U.S. regulations. Any U.S. person receiving this report and wishing to effect a transaction in any security discussed herein, must do so through a U.S. registered broker dealer. BNP Paribas Securities Corp. is a U.S. registered broker dealer. By accepting this document you agree to be bound by the foregoing limitations.

© BNP Paribas (2004). All rights reserved.

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