HINDSIGHT APPLICATION IN THE HIGH COURT OF JUSTICE NO 9527 OF 2011 CHANCERY DIVISION COMPANIES COURT IN THE MATTER OF MF GLOBAL UK LIMITED (in Special administration)

AND IN THE MATTER OF THE INVESTMENT BANK SPECIAL ADMINISTRATION REGULATIONS 2011

HINDSIGHT APPLICATION 18/19 JUNE 2012

EXPERT REPORT OF DR M. DESMOND FITZGERALD

7TH SEPTEMBER 2012

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1. OVERVIEW 1.1 In this Report I deal with various issues relevant to the Application in the

Matter of MF Global UK Limited (in Special Administration) made by the Joint Administrators of MF Global UK Limited on 18/19 June 2012.

1.2 EXPERIENCE AND QUALIFICATIONS 1.2.1 At the present time I am Chairman and Chief Executive of Equitable House

Investments Limited – a firm which specialises in the design of arbitrage, volatility trading and risk management strategies. During the period since 1993 when Equitable House was founded, I have had experience of proprietary volatility and arbitrage trading in fixed income, equity and commodity markets including the UK, US, Europe and Asia. Such trading has included equity and commodity derivatives trading, arbitrage trading worldwide, and volatility and relative value trading in equities, commodities and fixed income.

1.2.2 I am also currently a Partner in Unique Investment Advisers LLP, an FSA

regulated partnership specialising in the provision of investment advice to high net worth individuals and institutions, and Chairman of Unique Consultants Limited, which is a specialised financial training and risk management consulting firm.

1.2.3 During the period 1988 – 93, I served as Director and Head of Arbitrage at

Mitsubishi Finance International Plc, the securities arm of Mitsubishi Bank. In that role I was responsible for all exchange traded and over the counter derivatives activities in the areas of fixed income, equities and commodities. I was also involved with the structured product group in designing structured products for clients, pricing them and then managing the risks within the Arbitrage Group. During the period 1991 – 93, I also acted as Head of the Investment Management Group at Mitsubishi Finance International Plc.

1.2.4 My previous professional experience includes serving as Chief Economist and

Head of Planning at Credit Lyonnais-Alexanders, Laing and Cruickshank, Chief Economist at Chemical Bank, London, and Senior Economist at J & A Scrimgeour.

1.2.5 My academic background has been in Finance and I hold a Ph.D in Finance

from the University of Manchester, and a B.A in Economics from the University of York. My previous academic posts have included a National Research Fellowship at Princeton University, Associate Professor of Finance at New York University, Senior Lecturer in Finance at City University, London and the Ernst and Whinney Chair in Finance at the University of Strathclyde. I have served as the Chairman of the Financial Options Research Centre at the University of Warwick, and am also a member of the Futures and Options Committee of the Securities Institute.

1.2.6 Further details of my professional experience can be found in my full C.V.

appended as Appendix 1 of this Report.

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1.2.7 As a consequence of my professional and academic experience, I am familiar

with the trading of and investment in equities, fixed income and commodities in emerging and developed markets, as well as other forms of associated derivatives including credit derivatives. I also have an extensive knowledge of the asset management and hedge fund industries, including the role of managers, investment managers and brokers, valuation agents and financial regulators.

1.3 INSTRUCTIONS

This report has been prepared for the Court pursuant to a request by Macrae & Co LLP, the solicitors acting on behalf of Schneider Trading Associates Limited. I attach my letter of instructions as Appendix 2 to the Report. I set out the particular issues on which I express my Opinion in the relevant sections of this Report.

1.4 DOCUMENTATION

For the purpose of producing this Report I have had access to a variety of documents. I attach a list of the documents I have relied on in Appendix 3 to this Report.

1.5 EXPERT’S DECLARATION

I, M. Desmond Fitzgerald, declare that:

1.5.1 I understand that my duty in providing written reports and giving evidence is to help the Court, and that this duty overrides any obligation to the party who has engaged me. I confirm that I have complied with this duty and will continue to comply with this duty;

1.5.2 I have endeavoured to include in my report those matters, which I have

knowledge of or of which I have been made aware, that might adversely affect the validity of my opinion;

1.5.3 This report has been prepared in accordance with the Draft Code of

Guidance for Experts and any Practice Direction, which may supplement or supersede it;

1.5.4 I have indicated the sources of all the information I have used;

1.5.5 I have not, without forming an independent view, included or excluded

anything which has been suggested to me by others (in particular my instructing lawyers);

1.5.6 I will notify those instructing me immediately and confirm in writing if

for any reason my existing report requires any correction or qualification; and

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1.5.7 I understand that:

(a) my report, subject to any corrections before swearing as to its correctness, will form the evidence to be given under oath or affirmation;

(b) I may be cross-examined on my report by a cross-examiner assisted

by an expert;

(c) I am likely to be the subject of public adverse criticism if the Court concludes that I have not taken reasonable care in trying to meet the standards set out above; and

(d) I confirm that I have not entered into any arrangement where the

amount or payment of my fees is in any way dependent on the outcome of the case.

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2. OVERVIEW 2.1 I have been asked to provide my views on “the extent to which it is possible,

in relation to the range of financial instruments to which CASS 7 applies, to estimate the market value and mark-to-market value of open positions at the Primary Pooling Event (‘PPE’) of a firm”.

2.2 A glossary of terms used in this Report can be found as Appendix 4 to the

Report. 2.3 As I understand it CASS 7 applies to the range of financial instruments

specified in Section C of Annex 1 of MiFID. I have looked at the list of instruments, and confirm that it would cover all the instruments likely to be traded by customers of a firm such as MFGUK. This list includes both exchange traded and OTC instruments, including cash assets, futures, forwards, swaps, options both vanilla and exotic, credit derivatives and so on

Marking to Market, Market Values and Market Prices 2.4 At the outset, it is important to consider the meaning of the two concepts of

“market value” and “mark-to-market value” of a customer’s risk positions. Mark to market valuation, as will be discussed in detail below, involves the revaluation of a customer’s positions in line with prevailing market prices, generally the mid-prices for the underlying asset or assets in question. However, such mark to market prices are not necessarily accurate measures of the market price because they generally do not reflect the market bid-offer spread, the size of the customer’s position, the current state of liquidity in the market, the nature of the underlying asset, and numerous other factors. Market value can also be a concept distinct from market price. International Valuation Standards (IVS)1 defines market value as “the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”. This can be viewed as distinct from the market price, which is simply the price at which a trader can transact a specific volume of an underlying asset at a specific time. In inefficient disequilibrium markets, market values can be perceived as different to market prices for a prolonged period.

2.5 In his second Witness Statement, Mr Richard Heis contrasts liquidation values

for a client position with a position’s “market value” on another date, such as the PPE. He defines liquidation values as the actual value obtained when a position is closed out. He defines market value as the price at which a customer would buy or sell an asset or a particular position at a given time, so

1 The International Valuation Standards (IVS) are developed and maintained by the International

Valuation Standards Council (IVSC), which is an independent organisation that develops and promotes technical and ethical standards for the conduct of valuations on which investors and others rely. The IVSC works cooperatively with national professional valuation institutes, users and preparers of valuations, governments, regulators and academic bodies, and is responsible for developing the International Valuation Standards and associated technical guidance.

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that the “market value is generally regarded as the price that a willing buyer or seller, dealing fairly and on arm’s length terms would agree as at a given time”. I would regard Mr Heis’s definition as equivalent to the IVS definition provided in paragraph 2.3 above.

Concept of Slippage 2.6 Thus, there is (i) a “mark to market value”, which is simply, in my view, an

accounting number used to reflect current market conditions in a broker’s customer positions, mostly for margining purposes; then (ii) a “market value” which reflects potential transaction prices in an informationally efficient and liquid market; and (iii) a market price which reflects the price at which an actual position can be transacted in an actual market. The concept that links the various definitions is that of slippage. Slippage is defined as the difference between an average execution price and the initial mid-point of the bid-offer spread, for a given quantity of the instrument to be executed. The level of slippage will depend on a whole range of factors including the nature of the instrument traded, current market conditions, the degree of aggressiveness of the buyer or the seller, and the volume that is desired or required to be traded. Of course, it must be remembered that although mark to market prices are generally, though not always, available for most assets, actual market prices can only be observed after a transaction has taken place. While a broker or a customer can estimate what the degree of slippage will be between a mark to market price and an actual market transaction price, there is no guarantee that that is the level which will be observed with respect to a specific trade.

The Mark to Market Process 2.7 In any case, I will first describe the process of marking to market for a

financial instrument or group of financial instruments in more detail. When a customer trades through a broker, he will buy or sell a financial instrument at a specific trade price. For instance, a customer might buy a futures contract based on the FTSE-100 index at a price of 5500 at £10 per point. The initial contract value at which the future has been purchased will therefore be (5500 x £10) or £55,000. Over time, clearly the FTSE-100 index level will rise or fall, and the customer’s position will show a profit/loss. For instance, if the FTSE-100 future fell to 5000, then the customer would only be able to sell what he had purchased at a price of 5000, equivalent at £10 per point to £50,000. Clearly if the customer who paid £55,000 for the future, sold it for £50,000, then he would have lost £5000. The term marking to market means the process of valuing and reporting a customer’s positions in line with the current market prices for the positions, as opposed to the prices at which they were originally traded. Thus in the case described above, a simple mark to market report might look as follows.

FTSE-100 FUTURE ORIGINAL PURCHASE PRICE 5500 ORIGINAL POSITION VALUE £55,000 CURRENT MARKET PRICE 5000 MARK TO MARKET POSITION VALUE £50,000 POSITION PROFIT/LOSS £5000

Marking to Market : Exchange Traded Positions 2.8 With the customers of a broker such as MFGUK, it is likely that all their

positions will be marked to market on a daily basis, and the results reported to them. Of course, numerous issues arise in such a marking to market process for complex and numerous customer positions. In the case of exchange traded positions, including cash, futures and option positions, official settlement prices will generally be provided at the close of trading on a specific day, and those would represent an obvious source of mark to market prices for exchange traded positions. However, it is also obvious that exchanges close at different times especially across time zones. So, for instance, if positions were to be marked to market at 21.30 in the UK, a customer’s US positions would be being marked at almost contemporaneous prices, whereas the UK position prices would be, maybe, five hours old, and any Japanese position prices would be more than twelve hours old. Self-evidently if there had been a major collapse on Wall Street in the last couple of hours of trading, the UK and Japanese mark to market prices would not adequately reflect the prices at which those positions could be purchased or sold, if the UK and Japanese exchanges were open.

2.9 The position becomes even more nebulous with positions based on markets

that trade continuously without fixed trading hours. Consider a customer of MFGUK who held a position in foreign exchange based on the Euro/USD exchange rate. Such a liquid FX market trades continuously over the entire 24 hour day. Hence the broker will need to choose a specific time to monitor the Euro/USD FX rate, to carry out the mark to market valuation for the customer’s position.

Marking to Market : OTC Positions 2.10 Similarly for Over The Counter (OTC) positions traded with a market

counterparty, there will be a range of decisions that need to be taken by a broker with regard to the marking to market process. I will illustrate this with the case of a simple interest rate swap, where the customer has agreed to pay a fixed rate of interest in exchange for a floating rate of interest. The general position will be that if market interest rates rise, the customer will benefit, but if interest rates fall, the customer will suffer. In order to assess the mark to market profit or loss for such a position, the position will need to be valued in line with the current pattern of interest rates in the market using an appropriate valuation model. So the first question is whether the broker estimates the mark to market values of the position internally, or asks the original

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counterparty to the trade for a mark to market value, or asks a range of swaps traders for fair prices. And, of course, the mark to market values from a range of counterparties may well vary, and the broker will have to have a system for producing a single MTM value from that data set. The broker would also need to decide, if relying on other market participants for prices on OTC positions, at what time to sample the market, bearing in mind some market participants will tend to be slower than others in their response times.

Quality of Mark to Market Prices 2.11 It is also important to realise that the quality of mark to market prices may

vary significantly depending on the source, and type of instrument. Thus for liquid futures, cash equities, government bonds and FX, one would expect official settlement prices or screen prices to provide an accurate picture of the then current traded prices in the market. Model based prices for such instruments as interest rate and currency swaps, credit derivatives etc may be less accurate, in that they will be influenced by the structure of the provider’s book.2 Illiquid financial instruments such as individual corporate bonds, emerging market equities and debt, and many options especially out of the money options, may have prices that are infrequently updated by traders, so that they could reflect market conditions days or weeks earlier rather than currently.

2.12 In any case, it is evident that a total set of mark to market prices for all traded

financial instruments will represent a considerable quality range, depending on the market structure for each instrument, and the available liquidity in specific markets. Moreover, it must be remembered that a mark to market price will be a single value. As such, it cannot represent a price at which a financial instrument can be bought or sold, even exactly contemporaneously with the time of the mark to market price. This is because the vast majority of mark to market prices will represent a mid-market price at the time of observation. Exchange Official Closing Settlement prices can be regarded as mid-market prices at the close of business on a specific trading day. That is, the mid-market price would represent the middle of a conventional bid-offer spread for the underlying asset, although specific Exchange Settlement Price procedures might mean the final closing price was nearer to the bid or offer level. The mark to market price for all financial instruments would, in the vast majority of cases, represent for a position, a better or more advantageous price than could be achieved, if the position was to be closed in the market even at that precise time.

2.13 The normal size of the bid-offer spread will clearly vary between financial

instruments and markets, and no doubt will vary through time in line with prevailing market conditions. A position in a liquid stock index futures contract, say the S+P500, may have a bid-offer spread which is only one or two ticks, where a tick represents the minimum price fluctuation allowed for a contract. A bond such as a US Treasury bond may have a bid-offer spread of

2 For instance, a counterparty who already has a large number of swaps where it is paying fixed may be more reluctant to add another such position, except at an offmarket price, than a different counterparty.

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0.01%-0.02%. By contrast, a position in a very illiquid option contract based on an unusual asset may have a bid-offer spread of ten percent or more around a mark to market price.

2.14 Even for standard liquid financial instruments trading in normal market

conditions, mark to market prices cannot be regarded as prices at which actual market trading would or could occur. The concept of marking to market should be regarded as a convenient accounting tool, as opposed to a realistic assessment of the market values of a set of positions in financial instruments.

Role of the Order Book 2.15 In actual markets, the lack of realism of mark to market prices is even more

severe than simply reflecting the effects of conventional bid-offer spreads. This is because actual trading prices for financial instruments are not independent of volumes. Thus, if one examines, say, a current quotation for the price of an individual stock, one might observe a best level of 500-505. That is, a customer can trade with the market by either selling the stock at 500 or buying it at 505. But in practice, that price set will also be accompanied by numbers showing the volume each price is good for. Thus the actual screen might show

STOCK BEST BID SIZE BEST OFFER SIZE

ABC 500 20,000 505 50,000

So in the market, the customer could sell up to 20,000 shares of ABC at a price of 500, and could buy up to 50,000 shares of ABC at a price of 505. But if the customer wished to sell immediately a larger amount than 20,000 shares, he would probably not be able to achieve a sale price as advantageous as 500.

2.16 It is useful to bring in the concept of the order book to further explain this volume effect. In paragraph 2.15, the best bid was shown as 500 for 20,000, but behind this best bid probably lay a range of other less advantageous bids. For example, one might envisage the following set of bids:

PRICE 500 499 498 497 496 495 AMOUNT 20,000 10,000 20,000 20,000 40,000 40,000

So if a customer wanted to sell 150,000 shares immediately, he would have to hit all the bids down to 495, and the average achieved sale price would be 496.87. That would be 3.13 worse than the best bid price, and 5.63 worse than the likely mark to market price of 502.5 (the mid-point of the 500-505 bid offer spread).

2.17 Such a deterioration in the achieved price is the result of what I defined as slippage in paragraph 2.6 above. What this means is that not only is a single mark to market price not a correct measure of the market value of a set of positions, but neither would be the best bid and offer prices if the set was valued on that basis, independent of the size and nature of the positions. For a

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complex set of varied positions in a range of financial instruments, the mark to market price could deviate from the market price by a substantial margin.

Market Prices for Different Types of Position 2.18 One can illustrate this point by considering the range of positions that might be

held on behalf of customers by a broking firm such as MFGUK. As I have already mentioned the most liquid cash and futures instruments may display regular bid-offer spreads in the market of no more than a tick or two, but that would not be independent of volume. Suppose one was looking at a position in FTSE-100 futures, where the current price was 5499-5501, and the position held was 1000 contracts. On the assumption that there was then no information-driven movement in the FTSE-100 index, trades of 10-20 contracts could no doubt be carried out at the bid-offer spread of 5499-5501. However, any attempt to trade quickly out of 1000 contracts would rapidly become apparent to the market, and market makers would move the futures price against the trader. The net actual price might be five to ten index points or more away from the mid-price observed in the market before the trade.

2.19 Although exchange traded cash and futures contracts may show only a modest

degree of slippage, the same will not be true of exchange traded option positions, especially out of the money options, where the market price is higher than the strike or exercise price in the case of puts, and lower in the case of calls. Such option contracts are generally much more illiquid than the underlying assets, and even in normal market circumstances, finding the other side of a potential trade in an out of the money option can be difficult. For such illiquid option contracts, movements in bid-offer spreads and prices occasioned by high volumes of closing trades within a limited period of time could be very large. I would not be surprised to find that a large short-term trade in an illiquid out of the money exchange traded option might require a ten or twenty percent premium or discount to a mark to market price.

Example of an Out of the Money Option 2.20 For instance, consider a significantly out of the money put option on the

FTSE-100 index. The value of such an option will depend on various market inputs including the current level of the index, the maturity of the option, interest rates and dividend yields, and most importantly (and not directly observable) the volatility (degree of variation) of the index returns. Assuming the current date is 16/8/12, I observe the FTSE-100 index trading at 5832, and September 5675 strike put option quoted at 55-58 with no volume traded as of 09.40am. The price bid-offer spread can also be cast as a bid-offer spread in implied volatility, when it would become 15.75% - 16.22%. This thinking of options being traded at a bid-offer spread in volatility is common practice for derivatives traders. If a trader wished to trade out of a large position, say 200 lots, relatively quickly, he would no doubt face a volatility spread larger than the one quoted. I would not be surprised if the volatility spread became 15% - 17%, even in reasonably normal market conditions. Again each of these volatilities would suggest a different price for the option. In this case, the price spread equivalent to a 15% - 17% volatility spread would move to

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50 - 63. That compares with a mark to market mid price of 56.5. So the actual prices for a speedy trade in a 200 lot position would represent an 11.5% premium or discount to the mark to market price.

2.21 The further issue is that even with exchange traded contracts, the slippage

effects are cumulative. The forced liquidation of an out of the money option position based on an asset which is itself thinly traded could involve an enormous degree of slippage. If the forced liquidation was occurring in market conditions that were chaotic, then there might well not be any price to trade for significant periods of time. The example of certain credit derivatives, and traditional sub-prime mortgage-backed securities, during the credit crisis in 2008-09 immediately springs to mind. As Christopher Whalen remarks in his 2007 article “Collateralised Debt Obligations: A Triumph of Greed Over Fear”, “it is ridiculous to apply fair value accounting to assets that have no market”.3 Although this article specifically refers to CDOs, the statement would equally well apply to all the types of assets referred to in Section C of Annex 1 of MiFID.

Market Prices and OTC Positions 2.22 Problems with mark to market prices not adequately reflecting trading prices

become even more apparent with OTC positions in interest and currency swaps, swaptions, credit derivatives, exotic options and so on. The prices of such instruments are inherently model-based, and require complex valuation models to turn a set of market inputs such as interest rate and volatility curves into a fair price for a given product. This creates several major issues for the mark to market process. Firstly, each market counterparty may have its own valuation models and its own set of curves, which will therefore generate different instrument prices. Secondly, prices shown to the market by specific traders may reflect the current state of their portfolios, as well as general market inputs. For instance, if a trader is already holding a large number of call options on a specific asset, he may be very reluctant to add further to the position through a trade. Hence his bid price for such options will be lower than other traders. Pricing not to trade is a common feature of OTC markets. I have personally seen cases where major financial institutions have been apart by as much as 50 percent in their indicative pricing of complex products. What would be a sensible mark to market price for an OTC product, if a broker approaches the conventional five market traders and got back the following?

TRADER RESPONSE

1 Not willing to quote 2 100 Offer. No bid 3 75-125 4 50 Bid. No offer 5 50-90

3 Collateralised Debt Obligations : A Triumph of Greed over Fear, Christopher Whalen, Seeking Alpha, June 26,2007. Attached as Exhibit 1.

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Self-evidently, the problems with mark to market prices and high degrees of slippage are even more evident with OTC positions especially in complex instruments, than with exchange traded products.

2.23 It is this interplay of potential illiquidity in the underlying asset, features of specific derivatives based on that underlying asset, and the required transaction timeframe, that has a major effect on potential slippage. In such circumstances I would question whether any realistic market would exist for a specific position in a reasonable timeframe. As an example, consider a sizeable option position in a rare metal market such as Rhodium – maybe a put option on 5000 tonnes. It would be difficult quickly to close a 5000 tonne position in Rhodium, without needing to pay away a very significant premium or discount. The number of counterparties who would be willing to quote to trade a put option on that quantity of Rhodium would be extremely small – indeed, it is quite possible that no realistic quotes would be available.

2.24 The contention that a mark to market price determined at a specified point in

time represents a firm trading or market price, or a true fair price, is flawed, in my view. All underlying asset markets are constantly fluctuating in line with new information, trading in other markets, customer order flows etc. The concept of an equilibrium stable price at which positions can be closed is actually meaningless. The only true price is the one that a trader achieves on an actual trade at a specific moment in time, and even that is not guaranteed to remain available for the next few seconds. Certainly a mark to market value based on exchange closing settlement prices will not necessarily be a good forecast of what actual trading prices may be many hours later when the market reopens. It is worth remembering that the FX market in liquid currencies is the only truly continuous market.

Impact of a Broker Liquidation 2.25 It is also worth remembering that the very fact of MFGUK going into

administration could significantly impact on the prices at which the firm’s customer positions can be traded out of. Other marketmakers, for example, will be aware that the exchanges will have to carry out forced liquidations of major positions, and in such circumstances will certainly widen bid-offer spreads, and if they suspect the direction of the overall balance of the positions to be liquidated, will likely move prices against the traders or exchanges carrying out the liquidations of the positions.

2.26 My view therefore is that the major issues involved in using mark to market

prices at a specific time to represent market valuations of financial instruments in a liquidation environment, are such as to make them substantially unfit for purpose in that regard. Depending on the underlying instrument and the values that have to be liquidated, the mark to market prices could range between being fairly close to the likely real market price for liquidation to being half or double the likely real price. Just as the only true prices are those at which a trade actually occurs, so the only true values for a set of positions to be liquidated are those at which liquidation trades actually occur.

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Summary 2.27 To sum up, mark to market prices are not representative of actual market

values because they do not take into account market bid-offer spreads, trade execution slippage, pricing inaccuracies in illiquid instruments, uncertain model-based pricing in OTC products, and feedback effects in actual liquidation trading. I do not believe any reasonable financial markets participant would choose to rely on mark to market prices rather than actual traded prices to establish the value and profit/loss of a set of open positions. Further as stated in paragraph 2.3 above, the concept of market value can also be viewed as distinct from market or trade prices. Again I do not believe any reasonable financial markets participant would choose to rely on theoretical market values rather than actual traded pieces to establish the value of and profit/loss of a set of open positions.

2.28 In relation to most of the financial instruments to which CASS 7 applies, it

would be possible to establish reasonable mark to market prices on a particular day. However, for the reasons explained in this Report, I do not believe such prices provide an accurate assessment of the prices at which such instruments can actually be traded in the market, especially for the less liquid instruments and/or OTC positions. As regard to market values as opposed to actual trade prices, I do not believe any reasonable financial markets participant would know what such values were in relation to a set of open positions. Given the degree of slippage present in financial markets for the range of instruments covered under MiFID, and the potential inefficient structure of many markets, the only reasonable estimate of a set of market positions being liquidated is by reference to the actual trade prices achieved when the liquidation process occurs.

STATEMENT OF TRUTH I have read and am aware of the requirements of CPR Part 35, the practice direction that supplements it and the Protocol for the Instruction of Experts to give Evidence in Civil Claims. I confirm that I understand my duty to the Court, and that I have complied with and will continue to comply with that duty. I confirm that I have made clear which facts and matters referred to in this report are within my own knowledge and which are not. Those that are within my own knowledge I confirm to be true. The opinions I have expressed represent my true and complete professional opinions on the matters to which they refer.

SIGNED DR M. DESMOND FITZGERALD DATED 7TH September 2012

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EXHIBIT 1

Collateralized Debt Obligations: "A Triumph of Greed Over Fear" June 26, 2007 by Christopher Whalen includes: BCS, BSC, GS, LEH, MER, MS "When spreads go to zero, default is assured," opined IRA co-founder and CEO Dennis Santiago during a meeting with some like-minded financial analysts late last week. The occasion which gave rise to his remark: a discussion about integrating market and regulatory data sets to support safety and soundness analytics of US banks.

Around about that same moment, in New York some of our former colleagues at Bear Stearns (BSC) were ending a tough week navigating the illiquid, no-visibility world of hedge funds and collateralized debt obligations. You've read the details in the newspaper reports. Here's our take:

First, kudos to the Bear boyz for owning up to the obvious before the rest of the Street. We've been writing about the valuation issues facing the opaque OTC market for CDOs and similar designer securities for some time -- and with little gratification.

Now finally a hedge fund sponsored by BSC acknowledges same, but what about the dozens -- many dozens -- of other hedge funds and prime brokers out there with similar asset valuation and collateral margin issues festering behind the facade of mark-to-broker? The silence from some of the larger players in CDOs and similar assets -- not to mention their prime brokers and auditors-- is deafening.

Second, as and when the rest of the holders of CDOs and other illiquid assets make similar disclosures, a whole segment of the hedge fund sector -- and the secondary market for derivative securities like CDOs -- will crater. Why? Leverage. When collateral values fall, absent new capital, leverage ratios must follow.

We are especially amused to read press accounts of how CDO interest rate spreads are widening whole ratings break points in a single day, yet the agency ratings for these issues remain relatively unchanged. Could it be that the major rating agencies are thinking about withdrawing ratings for these issues entirely? If you cannot value an asset, can it be rated?

The lack of a publicly quoted market for CDOs and like assets is exacerbating the liquidity problems for these assets beyond the underlying economics, for example, in sub-prime real estate. Read: There's an opportunity here, somewhere, for the extreme risk oriented vulture. But don't be in a hurry to bid just yet. What the enterprising vulture can buy today can be bought cheaper tomorrow.

As the news accounts demonstrate, you don't just sell an asset like a CDO -- you actually have to organize special negotiated auctions, much like selling a private company or real estate. Since the dealer who sold you the paper won't make an

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outright bid, hedge funds are forced to hire investment bankers to run a formal sales process.

Yeah, that's right; a hedge fund actually needs to hire another firm of banksters to sell a block of CDOs or similar assets! And then pay them a fee! Perhaps this is part of the reason why Merrill Lynch (MER) and other creditors of the BSC hedge fund last week backed away from unilateral attempts to liquidate collateral.

Third, while the financial media is focused on the fate of various hedge funds, the lion's share of the risk resides with the dealers (and the ratings agencies which helped to price these deals). The use of leverage by hedge funds to enhance returns has the effect of placing ever increasing risk on the balance sheets of the prime brokers, especially for illiquid assets. As the WSJ notes: "More than anything else, this borrowing represents a triumph of greed over fear."

When you boil all the risks down to their essence, its all about reputation, as shown with the decision by BSC to bail out their wayward progeny. But there is a limit to the amount of capital which BSC or any prime broker can deploy to prop up the sagging market for CDOs. Look for the Fed to get involved in the CDO mess sooner rather than later, but hopefully before a major dealer is taken down. Just imagine what happens to the dollar and to the US financial markets if the Fed begins to accept this toxic waste as collateral on emergency discount window loans.

Along with BSC and MER, names to add to the CDO watch list include Lehman Brothers (LEH), Morgan Stanley (MS), Goldman Sachs (GS) and Barclays Bank (BCS). All have significant exposure to the hedge fund community, both in terms of counterparty risk exposure and forward revenue and earnings. But the entire dealer community is at risk because of the magnitude of the unrealized losses held by hedge funds and their lenders in the CDO sector.

Before the process of unraveling Wall Street's latest fiasco is complete, we suspect that a number of hedge funds will be forced to liquidate as their prime brokers hit the bid -- any bid -- for collateral. Just recall the work by the Corrigan Group a couple of years back, which noted that the difference between a market disturbance and a systemic risk event is that in the latter case, market participants act irrationally because of fear they won't get paid.

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APPENDIX 1

CV FOR M. DESMOND FITZGERALD

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DR. M. DESMOND FITZGERALD B.A(York), Ph.D(Manchester), is currently Chairman and Chief Executive of Equitable House Investments Limited, which specialises in the design and analysis of arbitrage and derivatives based strategies for clients. Dr Fitzgerald set up Equitable House Investments Limited after leaving Mitsubishi Finance International as a Hedge Fund specialising in derivatives and volatility trading in equities, commodities and fixed income. Dr Fitzgerald’s experience at Equitable House has given him a wide and deep experience in the trading of all types of derivative and structured products, the risk management of derivative positions, and the design and implementation of hedging and arbitrage strategies. Dr Fitzgerald is also a Partner in Unique Investment Advisers LLP, a Financial Services Authority (FSA) regulated partnership, specialising in the provision of advice to high net worth individuals on asset allocation, investment strategies and choice of structured products. He is also Chairman of Unique Consultants Limited, a financial training and risk management consulting firm. Prior to founding Equitable House, Dr Fitzgerald was Director and Head of Arbitrage at Mitsubishi Finance International Plc, the securities arm of Mitsubishi Bank. In that role, he was responsible for all traded and OTC derivatives activity in the areas of equities, fixed income and commodities. The arbitrage group also worked closely with the structured product group on the design of specific products for clients. During the period 1990 – 92, Dr Fitzgerald also acted as the head of the investment management division of Mitsubishi Finance International Plc. Prior to his time at Mitsubishi, Dr Fitzgerald served as Chief Economist and Head of Planning at Credit Lyonnais Securities, and as a Senior Economist at Chemical Bank. Dr Fitzgerald also has extensive academic experience. He served as the Ernst and Whinney Professor of Finance at the University of Strathclyde, where he was Head of the Department of Finance and Accounting. Previously he was an Associate Professor of Finance at New York University, Senior Lecturer in Finance at City University, London and a Princeton National Research Fellow in Economics. Dr Fitzgerald holds a B.A. in Economics from the University of York and a Ph.D in Finance from the University of Manchester. He has also acted as the Chairman of the Financial Options Research Centre at the University of Warwick, and is a member of the Financial Derivatives Panel of the Securities Institute. Dr Fitzgerald’s academic interests concentrated in the areas of derivatives valuation and risk management, financial forecasting, and the application of option strategies in investment portfolios. Dr Fitzgerald has published widely in academic and professional journals and is the author of “Financial Futures” and “Financial Options”. Dr Fitzgerald also has an extensive practice as an expert in litigation involving capital markets, financial derivatives, asset management and risk management. He acted for the London Metal Exchange in the Disciplinary Proceedings arising out of the Sumitomo copper trading matter, and as the main banking expert for Deloittes in the proceedings arising from the bankruptcy of Barings. He acted for the UK Inland Revenue in the prosecution for fraud of Ian Leaf, and also for the New Zealand and Australian Inland Revenue on various tax avoidance claims against major financial institutions. He has also acted for the Financial Services Authority in the UK on matters including false price reporting, insider trading and rogue trading. He has

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acted as an expert in a wide variety of commercial cases including the dispute between AIG and First Rand on gold derivatives activities, Parmalat versus JP Morgan and Credit Suisse on financial derivatives’ trades, and the Financial Services Compensation Scheme versus Abbey National on structured equity products. Dr Fitzgerald is an immensely experienced expert in all aspects of litigation involving financial markets. His specific areas of expertise include the valuation of derivatives and structured products, the analysis of risk management systems and procedures, the analysis of structured products, the analysis of negligence in fund management, and the evaluation of credit derivatives.

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CURRICULUM VITAE

NAME : MICHAEL DESMOND FITZGERALD ADDRESS BUSINESS : Equitable House Investments Limited 77 Long Lane London EC1A 9ET Tel: 0207-315-8999 Fax: 0207-315-8998 E-mail: ehidf@bloomberg.net HOME : 64 Northchurch Road London N1 3NY Tel: 0207-354-2751 CURRENT POSITIONS : Chairman & Chief Executive Equitable House Investments Limited

Partner, Unique Investment Advisers LLP Chairman, Unique Consultants Limited

Equitable House Investments Limited specialises in the design and implementation of derivatives based strategies for clients, and the analysis and pricing of structured products. Dr Fitzgerald is responsible for all the activities of the Company. Unique Investment Advisers LLP is an FSA regulated partnership providing investment advise to high net worth individuals. Dr Fitzgerald is one of the three managing partners. Unique Consultants Limited is a specialist financial training and risk management consulting firm. It also provides expert witness services in major legal cases. Dr Fitzgerald with his co-principal Professor Janette Rutterford is responsible for the activities of the Company. The company’s clients include numerous major financial institutions and international law firms.

PREVIOUS PROFESSIONAL POSITIONS 1988-1993 Director, Head of Arbitrage Mitsubishi Finance International plc Responsible for all arbitrage and Over The Counter

derivatives activities in interest rate, equities and commodities. Dr Fitzgerald also served in 1990-92 as Head of the Investment Management Division.

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1986-1988 Group Chief Economist & Head of Planning Credit Lyonnais - Alexanders Laing & Cruickshank Holdings Limited.

Responsible for a 13 person strong Economics, Department reporting directly to the Chief Executive.

1975-1977 Senior Economist and Head of Economics Department Chemical Bank, London. 1974-1975 Economic Analyst J+A. Scrimgeour Limited, Stockbrokers, London ACADEMIC EXPERIENCE 1985-1986 Ernst and Whinney Professor of Finance Dept of Finance and Accounting University of Strathclyde Acted as Chairman of the Finance Courses Committee, and as a Member of the Strathclyde Business School Board of Studies and the University Senate. Taught courses in Corporate Finance, Financial Management and Security Analysis. 1980-1986 Senior Lecturer in Finance, City University Business School Acted as Head of the Finance Division and Member of the Dean’s Advisory Committee and the Board of Studies. Taught courses in Financial Markets, Corporate Finance, Portfolio Analysis and Futures and Options. 1977-1980 Associate Professor of Finance Stern Graduate School of Business Administration New York University. EDUCATION 1958-1965 De La Salle College, Salford, Lancashire 9 0-levels, 7 A-levels. 1965-1968 University of York, Heslington, York B.A. (2.1) in Economics 1968-1969 Princeton National Research Fellow Department of Economics Princeton University, New Jersey, U.S.A.

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1969-1970 SSRC Fellowship, Department of Economics University of Warwick 1970-1974 University of Manchester (Manchester Business School) Ph.D awarded June 1975 “An Investigation into Information Flows on the U.K. Stock Exchange”. 1971-1973 Associate Scholar Institute for Advanced Studies in Management, Brussels. PUBLICATIONS A. RESEARCH PAPERS 1. “A Proposed Characterisation of U.K. Brokerage Firms and their Impact on

Stock Market Prices and Returns”, in E. Elton and M. Gruber (Eds), International Capital Markets, North Holland, 1975.

2. “Optimal Pricing and the Theory of the Second Best”, Methods of Operations Research, 34 Summer 1978, 89-103. 3. “A Simple Rational Expectations Macroeconomic Model: Theory and Evidence, Methods of Operations Research, 38 Summer 1979. 4. “Efficiency and Premiums in the Short-Term Money Market”, Journal of Money, Credit and Banking, 12, November 1980, 615-629. (with R.A. Fildes). 5. “The Properties of Alternative Measures of Inflation Expectations”, Money, Banking and Insurance, 1, 1981, 70-79 (with R.A. Batchelor). 6. “On the Neutrality of Fiscal Policy”, European Economic Review, 17, 1982, 87-98

(with G.Pollio). 7. “Fiscal Policy and Economic Activity in the United States”, Quarterly Review of Economics and Business”, 22, 1982, 126-129. 8. “The Price Behaviour of London Commodity Options”, Review of Research in

Futures Markets, 1, 1982, 90-104 (with S. Figlewski). 9. “Financial Regulation: A Survey”, Money, Banking and Insurance, 2, 1982, 1179-1191. (With R.A. Batchelor). 10. “The Use of Information in Balance of Payments Forecasting”, Economica, 50

1983, 249-258. (With R.A. Fildes). 11. “Options on Commodity Futures”, in M. Brenner (Ed), Options Pricing: Theory

and Applications, Heath Lexington, 1983, Massachusetts.

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12. “Money, Activity and Prices”, European Economic Review, 23, 1983, 299-314.

(With G. Pollio). 13. “Aluminium: The Next Twenty Years”, Journal of Metals, 34, December 1982, 37-42. 14. “Financing the Next Generation of Copper Projects”, Natural Resources Forum,

8, October 1984, 371-5. 15. “The Relationship between Official and Spot Oil Prices”, OPEC Review, Winter 1984. 16. “Trends in Business Finance in the U.K.”, Economia Aziendale, Volatility III,

No. 3, 1984, 407-414. 17. “Couverture et Arbitrage sur le London Financial Futures Exchange”, in “Les

Marches a Terme D’Instruments Financiers”, C. Lubochinsky + D. Marteau (Eds), Editions Eska, 1985.

18. “Trading Volatility” in “Risk Management and Analysis”, Carol Alexander (Ed),

John Wiley, 1998. 20. “The Role of Hedge Funds in International Financial Markets” M.D. Fitzgerald, C. Lubochinsky, L, McGinty, Economic Notes, vol 1, 2002 B. BOOKS Published “Financial Futures”, Euromoney, (Second Edition, 1992) “Financial Options”, Euromoney, 1987 “Directory of Financial Futures Exchanges”, MacMillan, 1987 In Progress Financial Options, Second Edition. Structured Equity Products, Prentice-Hall

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C. OTHER ARTICLES 1. “Monetary and Fiscal Policy and the Theory of Rational Expectations”. The Money Manager, Volume 8, No. 38, September 1979. 2. “Dollars, Substitution Accounts and SuperFunds” The Money Manager, Volume. 8, No. 46, November 1979. 3. “The Formation and Influence of Inflation Expectations”, The Money Manager, Volume. 9, No. 41, October 1980. 4. “The Impact of Index-Linked Instruments on the Building Societies”, The Banker, December 1981. 5. “Using the Financial Futures Market”, The Banker, April 1982. 6. “Financial Futures: Costs and Benefits”, The Banker, October 1982. 7. “Financing a Resources Boom: The Australian Example”, The Banker,

December 1982. 8. “Hedging Techniques”, (with Gordon Gemmill), published by London

International Financial Futures Exchange. December 1982. 9. “Trading Techniques (with G. Gemmill), published by London

International Financial Futures Exchange. December 1982. 10. “Innovations in Financial Futures”, The Banker, April 1983. 11. “Looking Forward to Financial Futures”, Euromoney Trade Finance

Report, No.2, June 1983. 12. “Options for Currency Hedging”, Euromoney Trade Finance Report, No. 3,

July 1983. 13. “Current Trends in Financial Futures Trading”, Arab Banker, 6, November 1983. 14. “Options in 1983”, “Futures in 1983”, Euromoney Year Book 1984. 15. “Banks’ Use of Financial Futures: A Set of Case-Studies”, published by

London International Financial Futures Exchange, May 1984. 16. “Traded Options: A Successful Innovation”, The Banker, May 1984. 17. “Changes in the U.K. Financial Services Industry 1984-85”, Newfin, Proceedings of 1st International Conference on Financial Innovation, 1985. 18. “Options in 1984”, Euromoney Year Book 1985.

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19. “Currency Futures and Options”, “Eurodollar Futures and Options”, “Long and Short Gilt Futures”. All published by the London International Financial Futures Exchange, 1985.

20. “LIFFE” in the City of London” LIFFE Yearbook, 1987. 21. “Option Building Blocks”, Risk Magazine 1990.

22. “Currency Protected Derivatives”, Futures and Options World, 1992. 23. “"Le Leggi sull'usure a l'evoluzione finanziaria"”, Medidea Review,

Volume 9, 2010.

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APPENDIX 2

LETTER OF INSTRUCTIONS

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MACRAE & CO LLP SOL I C I T O R S

Telephone : 020-73787716 Registered Office: Fax 020-7407 4318 59 Lafo ne Street

Shad Thames Direct e-mail: Gaskell@macraeco.com London SE I 2LX

Our Ref : JAT/29-012/rgg Your Ref:

25 July 2012

BY EMAIL & HAND

Or Oesmond Fitzgerald Unique Consultants Limited 77 Long Lane London EC1A 9ET

Dear Or Fitzgerald

Letter of instruction as expert witness

Thank you for agreeing to act as an expert witness in this matter. This will involve producing an expert report on the reliability of mark-to-market valuations of financial instruments as outlined below, responding to any questions in relation to your report, if necessary, participating in discussions with the opponent' s expert, as directed by the court, giving oral evidence at the hearing, and carrying out any other duties appropriate to the role of an expert witness, as directed by the court or instructed by us.

I set out below the background facts of the case and what is at issue between the parties, as well as the matters to be addressed by you.

Background facts

On Monday 3 I st October 2011 , at Spm, Richard Fleming, Richard Heis and Mike Pink of KPMG LLP ("the Administrators") were appointed joint special administrators of MF Global UK Limited ("MFGUK"), a UK based broker-dealer business.

On 3 May 2012 the Administrators issued an application to the High Court seeking directions from the Court regarding the appropriate valuation date for client money claims where clients held open positions as at 31 October 2011 (the "Hindsight Application").

The issue raised by the Hindsight Application is as follows:

• Reg is t e red as a Lim i ted Liability Partne rs hip in En g land & Wale s und e r no . 0 ( 3315 9 6 • • Re g ulated b y the So lic it o rs Re g ulation Author i ty •

A li st o f members can b e inspect e d a t o ur re g istere d office

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"Whether a client 's client money entitlement in respect of an open position is to be valued as at the P PE

(i) by reference to the market value or any mark-to-market value as at the PPE; or

(ii) by reference to the liquidation value "

Where:

"PPE" means the primary pooling event in relation to MFGUK, which event occurred on 31 October 2011 at 1700

"Primary pooling event" means an event that occurs in the circumstances described in CASS 7 A.2.2R

"CASS 7" means chapter 7 of the Client Assets sourcebook

At a directions hearing in the Hindsight Application on 18 June 2012, the Court appointed Attestor Value Master Fund LLP ("Representative Party A"), represented by Simmons & Simmons LLP, as representative respondent representing clients who would do worse by the application of hindsight, i.e. they would do better if a client' s client money entitlement in respect of an open position is to be valued as at the PPE by reference to the market value or any mark-to-market value as at the PPE.

Our client, Schneider Trading Associates Limited ("Representative Party B"), was appointed as a representative respondent representing clients who would do better by the application of hindsight, i.e. they would do better if a client's client money entitlement in respect of an open position is to be valued as at the PPE by reference to the liquidation value.

Enclosures

I have provided you with a folder containing the following documents:

(i) Administrators ' application dated 3 May 2012

(ii) Witness statement of Richard Heis dated 12 June 2012 on behalf of the Administrators

(iii) The exhibits marked "RH2" referred to in the witness statement of Richard Heis dated 12 June 2012

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(iv) Witness statement of Anke Heydenreich dated 16 July 2012 on behalf of Representative Party A

(v) The exhibits marked "AHI" to "AHI9" (inclusive) referred to in the witness statement of Anke Heydenreich dated 16 July 2012

(vi) CASS 7

(vii) CASS 7 A

(viii) Relevant parts of the FSA Glossary

In addition, I also enclose the following further documents:

(ix) Notes for experts on their duties and their evidence

(x) A copy of the reference materials which are referred to in the Notes, namely

(a) Part 35 of the Civil Procedure Rules and the accompanying Practice Direction

(b) The Civil Justice Council Protocol for the Instruction of Experts to give Evidence in Civil Claims (the Protocol), which is annexed to PD35

Issues to be addressed by you

The following issue will need to be addressed in your report:

"the extent to which it is possible, in relation to the range of financial instruments to which CASS 7 applies, to estimate the market value and mark-to-market value of open positions at the PP E of a firm. "

CASS 7 applies to firms that receive money from or hold money for, or on behalf of, clients in the course of, or in connection with their MiFID business. MiFID business includes a wide range of financial instruments specified in Section C of Annex I of MiFID (please see the definition of "financial instruments" in the enclosed extract of the FSA Glossary).

If, having read this, you feel that you may not, after all, have the appropriate experience and expertise, please let me know immediately.

Duties of an expert

You have a duty to exercise reasonable skill and care in carrying out your instructions and should comply with any relevant professional code of practice, but your overriding duty as an expert is to the court. Your primary function is to assist the court and, in this capacity, you must provide your unbiased opinion as an independent witness in relation to those matters which are within your expertise.

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An expert's duties are set out more fully in the attached Notes for experts on their duties and their evidence, and you should ensure that you comply with these duties and all other requirements set out in the reference materials.

Your report

In order to be used in evidence before the court, your report must comply with the requirements ofthe Civil Procedure Rules (which govern the conduct of civil proceedings in England and Wales) and the Civil Justice Council Protocol for the Instruction of Experts to give evidence in civil claims. You will find a checklist of the points which must be covered in your report in the Notes for experts.

Please let me know immediately if, at any time after producing your report, you change your views.

It is also important to let me know promptly if you feel that it is necessary to update your report after it has been served, for example because new evidence has come to light, so we can consider whether an amended version of your report or a supplementary report should be served.

Timetable

It is envisaged that following the service of your expert report, there will be a provision for the service of any expert evidence in answer and a meeting of experts. I will of course let you have a copy of the timetable for expert evidence once the same is agreed.

Please note that the final hearing date has been set for 30 & 31 October 2012. Please let me know immediately if, at any time between now and then, you become aware of any difficulty in attending the hearing. I will, of course, let you know if any of these dates should change.

It is important to meet deadlines set by the court as failure to do so can lead to costs sanctions or even a refusal to allow us to use your expert evidence.

Right to ask for directions from court

Experts are entitled to ask the court for directions to assist them in carrying out their functions if they feel that this is necessary. I would be grateful to you for notifying me if you intend to make an application for directions, in case it is a matter on which I can help (either by resolving any difficulties you may be experiencing and thereby avoiding the need to ask for directions altogether or by assisting with formulating the request).

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If you still feel the need to ask for directions, unless the court has directed otherwise, you are required under the Civil Procedure Rules to:

Let me have a copy of your proposed request for directions at least seven days before filing it at court; and

- Provide all other parties with a copy of your request at least four days before the request is filed.

Questions on experts' reports

Once your report has been served, the other party has the right to ask "proportionate" questions within 28 days, in order to seek clarification of the report. Please let me know as soon as you receive them if the other party sends any such questions to you instead of me, so we can discuss the appropriate action.

Provided that the questions are proportionate, you have a duty to answer them and your answers will form part of your report. A failure to answer the questions may result in the client being liable to sanctions including the debarring of your evidence from court. Please let me see a copy of your answers before finalising them.

If you have an issue with answering any of the questions raised or you believe that the questions are not properly directed to clarification of the report or are disproportionate or have been asked out of time, please discuss this with me.

I may also consult you on any questions which should be put in relation to the other party' s report.

I look forward to discussing the relevant issues with you once you have reviewed the enclosed documents. In the meantime, if you have any questions in relation to your role as an expert in this matter, please do not hesitate to let me know.

Yours sincerely

ROB GASKELL

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APPENDIX 3

LIST OF DOCUMENTS

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(i) Administrators’ application dated 3 May 2012

(ii) Witness statement of Richard Heis dated 12 June 2012 on behalf of the Administrators

(iii) The exhibits marked “RH2” referred to in the witness statement of Richard Heis dated 12 June 2012

(iv) Witness statement of Anke Heydenreich dated 16 July 2012 on behalf of Representative Party A

(v) The exhibits marked “AH1” to “AH19” (inclusive) referred to in the witness statement of Anke Heydenreich dated 16 July 2012

(vi) CASS 7

(vii) CASS 7A

(viii) Relevant parts of the FSA Glossary

(ix) Notes for experts on their duties and their evidence

(x) A copy of the reference materials which are referred to in the Notes, namely

(a) Part 35 of the Civil Procedure Rules and the accompanying Practice Direction

(b) The Civil Justice Council Protocol for the Instruction of Experts to give Evidence in Civil Claims (the Protocol), which is annexed to PD35

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APPENDIX 4

GLOSSARY

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AT THE MONEY Describes the situation where the strike or exercise price of a derivative is the same as the current market price of the asset. In the case of a call option, by contrast, OUT OF THE MONEY would be when the strike price was above the current asset price. IN THE MONEY would be when the asset price was above the strike price. BEST BID The highest price indicated to purchase a specific quantity of a financial asset BEST OFFER The lowest price indicated to sell a specific quantity of a financial asset BID The price at which a financial asset can be sold to the market. BID-ASK SPREAD The gap or spread between the bid and the ask price in the market. BID-OFFER SPREAD The same as the BID-ASK SPREAD BROKER A participant in financial markets who implements trades on behalf of customers normally in return for a commission. BUY The acquiring of an investment asset in exchange for cash. CALL (OPTION) A call gives the holder the right to buy an asset at a fixed price. . CASH ASSET A physical security such as an equity or a bond, as opposed to a derivative such as a future, forward or option CASS 7 Chapter 7 of the Client Assets Sourcebook (CASS) COLLATERALISED DEBT OBLIGATION A complex fixed income instrument where the cash flows to the investor are based on (collateralised by) a pool of loans and bonds. CORPORATE BOND A security issued by a corporation generally paying a fixed rate of interest per period till maturity, and with redemption at par at maturity. COUNTERPARTY The person or organisation with which one carries out a trade in the market: the opposite side of a cash or derivatives transaction. CREDIT DERIVATIVE Derivative whose payoff depends on changes in the credit quality of a specific corporation or financial institution or entity. Credit default swaps are typical credit derivatives, though there are many other types. DISCOUNT The percentage below an indicated price that is necessary to sell a specific volume of a financial asset. DISEQUILIBRIUM Describes a situation where asset or derivatives prices are not trading in line with the actual demand and supply in the market.

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DIVIDEND YIELD The level of dividends on a share or an index represented as a percentage return on the share or index over a specific period. EMERGING MARKET A sector within international financial assets made up of developing counties, where economic and political conditions may be more volatile. EQUILIBRIUM Describes a situation where prices are a stable function of the balance of well-informed supply and demand in the market. EXCHANGE OFFICIAL CLOSING SETTLEMENT The set of prices published officially by an Exchange at the close of trading on a specific day. EXCHANGE TRADED This term is used to describe financial assets or contracts traded on an recognised Exchange – in contrast to Over The Counter products. EXECUTION PRICE The price at which a trade or transaction is actually carried out in a financial market EXERCISE PRICE The price which the right to buy or sell underlying assets conveyed by ownership of an option can be implemented. EXOTIC Used to describe products which possess unusual, innovative or particularly complex features. FAIR PRICE The price at which a trader believes an asset should trade given current information in the market, or the price given for a derivative by a valuation model based on current market inputs. FINANCIAL INSTRUMENT Any specific asset or contract traded on a financial market including equities, bonds, FX, futures, forwards, swaps, options and so on. FIXED RATE A rate of interest which does not change for a specific period, or over the life of a financial instrument. FLOATING RATE A rate of interest which moves up and down through time in line with market conditions. FORCED LIQUIDATION The compulsory closing of a set of positions, often either because a client does not meet his margin requirements, or a broker fails to meet regulatory capital requirements. FOREIGN EXCHANGE The trading of one currency against another on a spot or forward basis. Colloquially the holding of balances in a currency other than that of an institution’s domicile. FORWARD Any transaction in a financial asset that is traded on the current date with settlement to occur at a different date.

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FTSE 100 INDEX A capitalisation-weighted index of the 100 most highly capitalised companies traded on the London Stock Exchange. FUTURES CONTRACT A forward contract which is traded on an organised exchange, and on which profits and losses have to be paid or can be redeemed on a daily basis – colloquially a margined forward contract. IN THE MONEY See AT THE MONEY INEFFICIENT Describes a market where traded prices do not reflect all publicly available information INFORMATIONALLY EFFICIENT Describes a market where traded prices appear to fully take into account all publically available information relevant to a specific asset. INTEREST RATE SWAP A financial contract which involves two counterparties agreeing to exchange interest rate payments, normally one payment is on a floating basis and the other on a fixed basis. INTEREST RATE The rate at which money is lent or borrowed, typically expressed in annual terms. LIQUID Describes an asset or position that can be sold without adverse impact on its market price over a reasonable timeframe. LIQUIDATION The process of closing a position in a financial asset by a purchase or sale in the market. LIQUIDATION VALUE The total value achieved for a position or set of positions when they are closed by equal and opposite transactions in a market. LIQUIDITY A measure of the ease with which a position can be liquidated without adverse impact on its market price over a reasonable time-frame. LOSS A reduction in the value of a position or transaction. For instance, the funding of a 6% loan stock by borrowing at 6.5% would create a loss of 0.50% per annum. LOT The trade of a single contract in a financial market. MARGINING Describes the system by which a Clearing House guarantees the performance of contracts by obtaining deposits from customers (initial margin) and organises the debit of losses and the credit of profits by those customers (variation margin). MARK TO MARKET PRICE The price for a security which is used to calculate the daily profit and loss on that security in the marking to market process.

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MARK TO MARKET The process of revaluation of a position or a book at regular intervals (generally daily) using the prevailing market prices for the assets contained therein. MATURITY The length of time until a financial asset such as a bond will be redeemed, or at which a derivative expires. MID-MARKET At the centre of the bid and after for an asset, position or derivative. Often used to describe the pricing of positions using market values that are the average of the bid and the offer. MID-PRICE The average for a specific asset of the high and low prices recorded during a trading day. MiFID Markets in Financial Instruments Directive: European Union Law that provides harmonised regulation for investment services across the European Economic Area. MODEL PRICE A price for a derivative derived from a valuation model as opposed to a traded price in the market. See THEORETICAL VALUE. NORMAL DISTRIBUTION The typical probability distribution of returns on financial assets when plotted on a graph. The shape of the graph is bell-shaped, and is fully described by the average (expected) return and the standard deviation (the dispersion of returns). OFFER PRICE The price quoted in the market at which an investor or trader can purchase a security. OPEN POSITION A position in a financial instrument that is exposed to market risk: a position that has not been hedged or closed with another position OPTION A financial instrument that gives the holder the right to buy (CALL) or Sell (PUT) a known quantity of a asset at a fixed price on or before a specific future date. ORDER BOOK The complete set of bids and offers with associated volumes for a specific asset on an Exchange or Financial market. ORDER FLOW The pattern of buy and sell transactions in a financial market through time. OTC (OVER THE COUNTER) This term describes financial contracts entered into privately by the counterparties as opposed to being traded on an organised exchange such as the London International Financial Futures and Options Exchange (LIFFE). OUT OF THE MONEY See AT THE MONEY PREMIUM The price at which a financial derivative, for example an option, can be bought or sold in the market.

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PRIMARY POOLING EVENT (PPE) A Primary Pooling Event, for a firm that becomes insolvent and where there is a shortfall in client monies, is a trigger for a notional pooling of all client monies, for every type of client money account, and an obligation to distribute them in accordance with client money distributions rates. PROFIT The positive change in the value of a position or set of positions that has occurred over a specific period of time. PUT OPTION The right to sell a specific quantity of an asset at a fixed price on or before a specific future date. QUOTATION A price provided by the market or market participants indicating the level at which a security can be purchased or sold. Also known as a QUOTE or a QUOTED PRICE. QUOTE A price provided by the market or market participants indicating the level at which an asset can be purchased or sold. QUOTED PRICE A price or yield for a financial instrument indicated by a market marker or professional counterparty in a financial market. RISK POSITION A position in a financial asset that is exposed to market risk – see OPEN POSITION. SCREEN PRICE A price for a financial instrument observable on an electronic dissemination mechanism SELL The disposal of an investment asset in exchange for cash. SELLER A person or institution who carries out the act of selling. STANDARD DEVIATION A measure of the dispersion of a NORMAL DISTRIBUTION. Colloquially it measures the size of the likely variations in asset returns around a trend over time. See VOLATILITY. STRIKE PRICE The fixed price specified for a derivative at which the holder has the right to buy or sell the underlying asset. STRIKE The price at which an option contract can be exercised. See STRIKE PRICE. SWAP A swap is an agreement between two counterparties to exchange payments related to the relative movements in two financial assets SWAPTION An option giving the right to enter into a specific swap on defined terms at a future date. THEORETICAL VALUE A value determined, generally for a derivative, from a valuation model as opposed to being observed in the market.

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THINLY TRADED Describes an illiquid market for a financial instrument where trades in the instrument are intermittent and of low volume. TICK The minimum price movement allowed for a derivative, futures or option, on an exchange. TRADE PRICE The price at which a trade or transaction is actually carried out on a financial market TRADING VOLUME The number of shares traded in a particular period, for example a day. TRANSACTION PRICE See TRADE PRICE U.S. TREASURY BOND A fixed income bond issued by the US Treasury as a general obligation of the US government. VALUATION MODEL A mathematical or other routine which generates fair prices for financial assets or derivatives based on a set of inputs for the levels of market factors. VANILLA A colloquial term used to describe a basic simple cash or derivatives transaction. VOLATILITY A measure of the amount by which an asset price is expected to fluctuate over a given period. Normally measured by the annual standard deviation of the daily returns on the underlying asset. VOLATILITY CURVE The set of appropriate volatility inputs for futures contracts at specific maturities. VOLUME The amount, or number of lots, of an underlying asset that is traded in a specific period.