property derivatives briefing seminar ii - nimbiz spr... · 1690s 1870s 1972 1973 the egg came...

Society of Property Researchers

Property Derivatives Briefing Seminar II

Property Derivatives: What’s in the Pricing? What’s

in the Future?


Thursday 2nd July 2009


Seminar Welcome

Welcome Chair

Iain ReidChief Executive and Chief Investment OfficerProtego Real Estate Investors LLP



Agenda• Real Estate Derivatives from First Principles: Interpretation of

Pricing– Christophe Cuny

Director: Property Derivatives, Eurohypo

• TRS Pricing: Rational Trading Window and Market Spreads– Colin Lizieri

Professor of Real Estate Finance; Director of Research for Real Estate & Planning, Henley Business School, University of Reading

• Listed Property Derivatives: Benefits and Applications– Stuart Heath

Director: Product Strategy, Eurex


SPR Derivatives Event – L&G ‌ July 2009

Real Estate Derivatives from First Principles: Interpretation of PricingChristophe Cuny

1 Real Estate – It’s Almost All Different

5Christophe Cuny ‌ SPR Derivatives Event – L&G ‌ July 2009

Classical Perspective

Efficient Market Hypothesis (EMH)

■ Impossible to outperform the market for a consistently

■ Random walk assumption

■ Generally accepted in traditional asset classes

Risk Management Implications

■ Hold large enough portfolio ⇒ Idiosyncratic risk is eliminated

■ Assume a Law of Large Numbers can be applied

■ Diversification is possible

Real Estate Stylised Facts

Real Estate and Alternative Assets Require Customised Risk Models

■ Real Estate vs. Traditional Asset Classes:

■ Cyclical: Long cycle vs. random walk assumption

■ Liquidity: Low transaction volumes vs. high frequency data

■ Inertia: Delay in responding to new information vs. quasi instantaneous adjustment

■ Arbitrage: Incomplete markets vs. dynamic, frictionless hedging. No hedge replication

■ Heterogeneity: More persistent asset specific differences vs. diversification

■ Indivisibility: Or near enough

■ Biases: Auto-correlation from appraisal smoothing

2 “I know it works in practice but would it work in theory?”


197319721870s1690s

The Egg Came First

Kairys, Joseph P., Jr., and Nicholas Valerio III, 1997, The market for equity

options in the 1870s, Journal of Finance 52, 1707-1723.

Black, Fischer, and Myron Scholes, 1972, The valuation of option contracts and a test of market

efficiency, Journal of Finance 27, 399-417. Using the diaries of an option

broker from 1966 to 1969, Black and Scholes (1972, p. 413).

Black, Fischer, and Myron Scholes, 1973, The pricing of options and

corporate liabilities, Journal of Political Economy

81, 637-654.

A market in equity options emerges in London during the stock market boom

of the early 1690s.

First Responses

Banks

Inflation models favoured but commonality proves superficial:

■ Index lag

■ Seasonality

■ Serial Correlation

But arbitrage pricing in inflation markets was possible: index-linked bonds allowed for this before inflation derivatives became swap–driven. No such parallel in Real Estate:

■ The Spot/Futures arbitrage is somewhat impaired by the fact that there is no Spot market in Real estate. The market is self-referential

■ Just about everything else gets in the way of conventional pricing: transaction costs, indivisibility, mean reversion and cyclicality, non-normality of returns…

Academia

■ The what the..? hard core die-hard arbitrage faithful. An anomaly in an otherwise perfect world.

■ The hey, what the… compromisers of Equilibrium Pricing

■ The Incomplete Markets theorists

No-Arbitrage Models

Buttimer, R. J.,Kau, J. B. and Slawson, V. C.,

A Model for Pricing Securities

Dependent upon a Real Estate Index, Journal of Housing

Economics, 6,16-30, 1997.

Buttimer, R. J.,Kau, J. B. and Slawson, V. C.,

A Model for Pricing Securities

Dependent upon a Real Estate Index, Journal of Housing

Economics, 6,16-30, 1997.

Baran, L. C., Buttimer, R. J. and

Clark, S. P., Calibration of a

Commodity Price Model with

Unobserved Factors: The Case of Real

Estate Index Futures, Review of

Futures Markets, 16, 4, 3, 2008.

Baran, L. C., Buttimer, R. J. and

Clark, S. P., Calibration of a

Commodity Price Model with

Unobserved Factors: The Case of Real

Estate Index Futures, Review of

Futures Markets, 16, 4, 3, 2008.

Ciurlia, P. and Gheno, A., A model

for pricing real estate derivatives with

stochastic interest rates, MPRA Paper

No. 9924, 2008

Ciurlia, P. and Gheno, A., A model

for pricing real estate derivatives with

stochastic interest rates, MPRA Paper

No. 9924, 2008

Patel, K. and Pereira, R., Pricing

Property Index Linked Swaps with

Counterparty Default Risk, Journal of Real Estate Finance and Economics, 36, 1,

2007

Patel, K. and Pereira, R., Pricing

Property Index Linked Swaps with

Counterparty Default Risk, Journal of Real Estate Finance and Economics, 36, 1,

2007

Björk, T. and Clapham, E.,, A Note

on the Pricing of Real Estate Index

Linked Swaps, Journal of Housing

Economics, 11, 418-432, 2002.

Björk, T. and Clapham, E.,, A Note

on the Pricing of Real Estate Index

Linked Swaps, Journal of Housing

Economics, 11, 418-432, 2002.

Some References (1)

Baum, A., Lizieri, C.,Marcato, G. and Ogden P., Pricing Inefficiencies in Private Real Estate Markets Using Total

Return Swaps, Working Paper presented at the AUEREA Conference,

2009.

Baum, A., Lizieri, C.,Marcato, G. and Ogden P., Pricing Inefficiencies in Private Real Estate Markets Using Total

Return Swaps, Working Paper presented at the AUEREA Conference,

2009.

Geltner, D. andFisher, J., Pricing and

Index Considerations in Commercial Real Estate Derivatives, Journal of Portfolio Management,

33, 5, 2007.

Geltner, D. andFisher, J., Pricing and

Index Considerations in Commercial Real Estate Derivatives, Journal of Portfolio Management,

33, 5, 2007.

Baum, A., Lizieri, C., Marcato, G., Pricing Property Derivatives, Investment Property

Forum, 2006.

Baum, A., Lizieri, C., Marcato, G., Pricing Property Derivatives, Investment Property

Forum, 2006.

Equilibrium Pricing – Inefficiency Pricing

Some References (2)

Radu Tanaru presents joint work with Frank

Fabozzi on new models for pricing property

derivatives using mean-reverting models with non-constant long-run

trend in Cambridgein 2009.

Radu Tanaru presents joint work with Frank

Fabozzi on new models for pricing property

derivatives using mean-reverting models with non-constant long-run

trend in Cambridgein 2009.

Otaka, M. and Kawaguchi. Y.,

Hedging and Pricing of Real Estate Securities

under Market Incompleteness, Working

Paper, 2002/2003.

Otaka, M. and Kawaguchi. Y.,

Hedging and Pricing of Real Estate Securities

under Market Incompleteness, Working

Paper, 2002/2003.

Incomplete Markets Pricing

Some References (3)

3 The Information Value of Property Derivatives


Ex-What?

Ex-Ante

■ Most pricing methodologies do not actually price Property Derivatives Ex-Ante

■ Pricing Property Derivatives Ex-Ante leads to significant differences with observed prices

■ The only Ex-Ante value of such approaches is the modelling of Property Derivatives that seeks to explain observed prices

■ Until the embryonic futures market develops or/and Total Return Swaps acquire significant liquidity, the egg will lead the chicken

Ex-Post

■ Once a price is observed, it carries significant information value

■ The Ex-Post analysis of prices is the only way to determine the value (if not the Ex-Ante price) of Property Derivatives

In Action (Using REDCalc 1.0)

More Granularity (Using REDCalc 2.0 Prototype)

Appendix I

18

REITS as Property Derivatives

Risk and Return: Real Estate or Not Real Estate?

Comparative Performance (TR/GBP)(1) NAV Discount Premium Index

FTSE 100 Index FTSE UK Gilts All Stocks IndexFTSE Global Hedge Index FTSE EPRA/NAREIT UK IndexFTSE ALL UK Commercial Property Index (NAV)

Inde

x Le

vel R

ebas

ed (3

1/12

/200

7 =

100)

70

80

90

100

110

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

(60.0%)

(50.0%)

(40.0%)

(30.0%)

(20.0%)

(10.0%)

0.0%

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

(16.0%)

(14.0%)

(12.0%)

(10.0%)

(8.0%)

(6.0%)

(4.0%)

(2.0%)

0.0%

FTSE EPRA UK Premium to NAV (LH)RED Implied LIBOR Spread (RH)

(1) To 31 August 2008Source: MSS FTSE and Bloomberg, Eurohypo

Appendix II

20

In Case of Emergency

What Implied Forwards Mean

■ Let us say that we wish to borrow money for one year starting one year from now and that our bank is unable to fathom the price for this forward starting transaction. We can roll our own instead:

■ We borrow money for two years today

■ Since we don’t need the loan until one year from now, we simply lend the money for one year

■ The net result or synthetic forward is that we have borrowed money for one year in one year

■ We have used no arithmetic at this stage, but we may benefit from visualising the transaction in a simple diagram:

Year 1 Year 2Borrow 2 Years

Lend 1 Year

Net (Synthetic) Result:Borrow For 1 Year in 1 Year

Appendix III

22

Further Information

For the Uninitiated

■ The Information Value of Property Derivatives

Eurohypo AG is authorised by the Bundesanstalt für Finanzdienstleistungsaufsicht.

© Colin Lizieri 2008 www.henley.reading.ac.uk

School of Real Estate & Planning

02 July 2009

Based on Research by Gianluca MarcatoBased on Research by Gianluca Marcato**, , Colin LizieriColin Lizieri**, Paul Ogden, Paul Ogden## and Andrew Baumand Andrew Baum**

* University of Reading* University of Reading# RPM Investment Management# RPM Investment Management

Pricing Property Swaps: Market Pricing Property Swaps: Market Efficiency, Trading Windows and MarginsEfficiency, Trading Windows and Margins

SPR Presentation July 2009 26

______ __ _ ____ ______ __ _ ____ Falling Off a Cliff? Falling Off a Cliff? IPD Index Swaps (£bn)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Pre 20

0520

05 Q

120

05 Q

220

05 Q

320

05 Q

420

06 Q

120

06 Q

220

06 Q

320

06 Q

420

07 Q

120

07 Q

220

07 Q

320

07 Q

420

08 Q

120

08 Q

220

08 Q

320

08 Q

420

09 Q

1

Notio

nal £

bn

TradesNotional Outstanding

•• Market Efficiency Requires Critical MassMarket Efficiency Requires Critical Mass•• What Are Implications of Fall in Volumes?What Are Implications of Fall in Volumes?


Pricing Around the TurnPricing Around the TurnStrip Margins by Maturity

Source: TFS

-2000

-1500

-1000

-500

0

500

Aug-06

Sep-0

6Oct-

06Nov

-06Dec-

06Jan

-07Fe

b-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-0

7Oct-

07Nov

-07Dec-

07

BPs

20102012

2008

•• 2012 Contract Sept 2006 +245bp2012 Contract Sept 2006 +245bp•• 2012 Contract Sept 2007 2012 Contract Sept 2007 --425bp425bp•• But is This a But is This a ““ForecastForecast”” of Returns to 2012? of Returns to 2012?


Equity Index Swap Margins Equity Index Swap Margins ……•• Investor Sells Equity Index Receives LIBORInvestor Sells Equity Index Receives LIBOR•• Can Use LIBOR Payments to Borrow CapitalCan Use LIBOR Payments to Borrow Capital•• Can Use Borrowed Capital to Buy EquitiesCan Use Borrowed Capital to Buy Equities•• Equity Portfolio Pays Equity Index LegEquity Portfolio Pays Equity Index Leg•• LIBOR Payments Cover DebtLIBOR Payments Cover Debt•• Therefore Therefore ““ZeroZero”” Risk Position Risk Position –– No PremiumNo Premium•• Actual Spreads Soon Converged to Actual Spreads Soon Converged to

Theoretical Position with Critical MassTheoretical Position with Critical Mass•• Counterparty Risk Outside Swap Margin?Counterparty Risk Outside Swap Margin?


Is Real Estate Different? Is Real Estate Different?

•• Cannot Invest in the Cannot Invest in the ““IndexIndex””– Diversification, Specific Risk and Tracking Error– Standard Arbitrage Model Will Not Work …

•• Index is Appraisal BasedIndex is Appraisal Based– Smoothing, Serial Correlation & Momentum

Effects•• Inefficiencies in Underlying Asset MarketInefficiencies in Underlying Asset Market

– High round trip transaction costs– Illiquidity and time to trade– Real management costs– Heterogeneity and “alpha”


Implications for Swap SpreadsImplications for Swap Spreads

•• Large Swap Spreads Rational? Large Swap Spreads Rational? •• Buyer AND Seller May Be Prepared to Cede a Buyer AND Seller May Be Prepared to Cede a

Premium to Trade in DerivativesPremium to Trade in Derivatives•• This Creates a This Creates a ““Swap WindowSwap Window”” around the around the

Neutral Zero MarginNeutral Zero Margin•• Actual Trading Will Take Place In That Actual Trading Will Take Place In That

Window, Determined By Supply and DemandWindow, Determined By Supply and Demand

SPR Presentation July 2009

Modelling the PriceModelling the Price

•• Need to Adjust Pricing for RiskNeed to Adjust Pricing for Risk– In efficient market, correctly discounted NPV = 0

•• Two Broad ApproachesTwo Broad Approaches– Arbitrage Approach– Direct Valuation of Contract– Should Give Same Answer …

•• Approach Adopted in ResearchApproach Adopted in Research– Examine NPV of contract on certainty equivalent

basis– Estimate what buyer, seller might pay as spread– Create a “swap window”

31


Pricing Swaps: Pricing Swaps: NPV/Certainty Equivalent ApproachNPV/Certainty Equivalent Approach

•• Equation 1 shows Baseline NPV for Buyer of Equation 1 shows Baseline NPV for Buyer of Swap Contract Including SpreadSwap Contract Including Spread

•• And for SellerAnd for Seller

•• Solve for the Spread/MarginSolve for the Spread/Margin•• Then Model Complexities Caused By MarketThen Model Complexities Caused By Market

( )

32

( ) )1( 1

*11

1 ,0

41

,1

∑=

−

+

⎥⎦⎤

⎢⎣⎡

⎟⎠⎞

⎜⎝⎛ −+++−−

=N

ii

i

iiIi

swapB Libor

NVSpreadSwapFeeLiborRPTRNPV

( ) ( )

( ) (2) 1

*11

1 ,0

41

,1

∑=

−

+

⎥⎦⎤

⎢⎣⎡ −−⎟

⎠⎞

⎜⎝⎛ −+−+

=N

ii

i

iiii

swapS Libor

NVRPTRSpreadSwapFeeLiborNPV

Motivation Stochastic Results ConclusionStatic Results


Factors Influencing SpreadsFactors Influencing Spreads•• Transaction CostsTransaction Costs

– Buyer and seller avoid transaction costs– Effects reduce with holding period / swap maturity– Effects are asymmetric …

•• Execution TimeExecution Time– Time taken to get into market lengthy– Can access swaps market swiftly– Impact will vary with underlying market trend

•• Appraisal and Smoothing EffectsAppraisal and Smoothing Effects– Index lags the market?– Beliefs about trends/momentum will affect spreads– Impact dampens quickly with tenor of swap

33


Some Preliminary ResultsSome Preliminary Results

•• First, model on a static basis First, model on a static basis –– taking long taking long run average market valuesrun average market values

•• Second, model using a stochastic frameworkSecond, model using a stochastic framework– Monte Carlo simulation model– Inputs based on historic values and volatilities– Examine the average buyer/seller and 5%, 95%

tails•• What will the margin be?What will the margin be?

– In an Efficient Market, trading at mid-point?– But what about a market without critical mass?

34


Static Model: Combined EffectStatic Model: Combined Effect

35

-10%-8%-6%-4%-2%0%2%4%6%8%

10%

1 2 3 4 5 6 7 8 9 10

Length of Swap Contract

Spre

ad BuyerSeller


Moving to a Stochastic ApproachMoving to a Stochastic Approach

36

•• Allow Real Estate and LIBOR Returns to VaryAllow Real Estate and LIBOR Returns to Vary•• Assume Stable But Volatile MarketAssume Stable But Volatile Market•• Allow for Index Smoothing EffectsAllow for Index Smoothing Effects

– Index is Smoothed– Underlying Real Estate is Not

•• Model Using Monte Carlo Simulation Model Using Monte Carlo Simulation ApproachApproach

•• Also Model Falling Market Scenario Also Model Falling Market Scenario – Current Results Unstable …


Stochastic Model: Combined EffectsStochastic Model: Combined Effects

37


Discussion / ConclusionsDiscussion / Conclusions

•• There is a rational trading window in which There is a rational trading window in which spreads/margins can fall;spreads/margins can fall;

•• MidMid--point pricing points to feasibly large point pricing points to feasibly large spreads for short tenors, but tending to zero;spreads for short tenors, but tending to zero;

•• BUT BUT …… this assumes efficiency and critical massthis assumes efficiency and critical mass•• In practice, unlikely to hold:In practice, unlikely to hold:

– Imbalance between short and long interest?– Function of state of market / market sentiment– Who will go short? Who is allowed to short?– Arbitrage and closing out positions?

•• Margins are NOT forecasts! Margins are NOT forecasts!

38

Listed Property Derivatives: Benefits and Applications


2nd July, 2009

FuturesA futures contract is a standardized contract to buy or sell a specified commodity of standardized quality at a certain date inthe future, at a market determined price.


The contracts are traded on a regulated futures exchange and are listed derivatives


The contracts are traded on a regulated futures exchange and are listed derivatives

The underlying asset to a futures contract need not be traditional "commodities" at all – for financial futures, the underlying asset can be currencies, equities or referenced items such as indices

Futures Exchange

’ In a well ordered society there will be a need for a market place with a lower class of person whose job it will be to sell to those who want to buy and buy from those who want to sell. They will commonly be those who are weakest in bodily strength and therefore of little use for any other purpose. ‘

The Republic, Plato, 375 BC

Futures Exchanges

1697 1697 –– DojimaDojima Rice Exchange, OsakaRice Exchange, Osaka1848 1848 –– Chicago Board of Trade ( CBOT )Chicago Board of Trade ( CBOT )1874 1874 –– Chicago Mercantile Exchange (CME)Chicago Mercantile Exchange (CME)1877 1877 –– London Metal ExchangeLondon Metal Exchange1982 1982 –– London International Financial Futures London International Financial Futures

Exchange (LIFFE)Exchange (LIFFE)1990 1990 –– Deutsche Deutsche TerminbTerminböörserse (DTB) (DTB) 1998 1998 –– EurexEurex (merger DTB & SOFFEX)(merger DTB & SOFFEX)

The Key Functions of the Exchange

StandardizationThe contracts traded on futures exchanges are always standardized. To help liquidity there is only a limited number of standardized contracts.

The determined future date is called the final settlement date and has a final settlement price determined by the exchangeThe official price of the futures contract published at the end of each day is the daily settlement price

TransparencyTo secure a fair price, determined by supply and demand (buy and sell orders) at the time of purchase or sale of the contract in an orderly market open to all

ClearingThere is a clear division of responsibility between provision of the trading facility (order book) and the settlement of subsequent trades. Settlement is the task of the clearing house whose role is to maintain the integrity and reliability of the marketplace.

To serve as central counterparty (buyer to every seller and seller to every buyer)To collect collateral (initial margin) to be used as cover for contract fulfilmentTo settle gains and losses every day (mark-to-market)To guarantee prompt settlement and contract delivery

Contract SpecificationsContract Specifications – Property Index Futures

Contract Product ID Underlying

IPD UK Annual All Property Total Return Futures

Eurex: PUKA

IPD UK Annual Index All Property Total Returns

Contract Value Contract has a Nominal Value of GBP 50,000

Settlement Contract is cash settled.

Price Quotation and Minimum Price Change Price is expressed as 100 plus the percentage total return in the year to the end of December.

The Minimum Price Change (”Tick”) shall be 0.05 points, this represents a value of GBP 25.

Minimum Price Change Contract Contract Value

%age Value

IPD UK Annual All Property Total Return Futures GBP 50,000 0.05 GBP 25

Contract Years 5 successive annual contracts are to be available. Contract Expiry is on an end of March cycle.

Final Settlement Day Final Settlement Day is the last trading day of March immediately following the calendar year that the contract applies to.

Daily Settlement Price Determined by Eurex based upon available quotes in the order book.

Final Settlement PriceFinal Settlement Price The final settlement price shall reflect the nominal par value of 100 plus the annual Total Return for the IPD® UK Annual All Property Index during the calculation year. The final settlement price shall be calculated to three decimal places and rounded to the next possible interval of 0.005, or 0.01, or multiples thereof; on the basis of the following formula:

Final Settlement Price = 100 * [ TRI t / TRI (t – 1) ]

Where:

TRI t = Total Returns Index Value at the end of the Annual Period

TRI (t – 1) = Total Returns Index Value at the beginning of the Annual Period

Final Settlement Price Example: Cal 09 at March 31st 2010

IPD® UK All Property Total Return Index as at 31st Dec 2008: 1178.0732

IPD® UK All Property Total Return Index as at 31st Dec 2009: 1007.2526

Final Settlement Price = 100 * [1007.2526/ 1178.0732] = 85.50

Prices in the Order Book

Prices in the Order Book / Broker Screens

OTC Prices > Futures PricesOTC - Total Return Swap Property Derivative Prices

Period Input Fixed Leg (bps)Beginning Ending Country Frequency Sector Returns Bid Ask Mid

31-Dec-08 31-Dec-09 UK Annual All Property Total Return -1550 -1450 -150031-Dec-08 31-Dec-10 UK Annual All Property Total Return -550 -450 -50031-Dec-08 31-Dec-11 UK Annual All Property Total Return -50 50 031-Dec-08 31-Dec-12 UK Annual All Property Total Return 200 300 25031-Dec-08 31-Dec-13 UK Annual All Property Total Return 350 450 40031-Dec-08 31-Dec-14 UK Annual All Property Total Return 425 525 475

Source: Tullet Prebon (TPPR)

OTC Prices > Futures PricesOTC - Total Return Swap Property Derivative Prices

Period Input Fixed Leg (bps)Beginning Ending Country Frequency Sector Returns Bid Ask Mid

31-Dec-08 31-Dec-09 UK Annual All Property Total Return -1550 -1450 -150031-Dec-08 31-Dec-10 UK Annual All Property Total Return -550 -450 -50031-Dec-08 31-Dec-11 UK Annual All Property Total Return -50 50 031-Dec-08 31-Dec-12 UK Annual All Property Total Return 200 300 25031-Dec-08 31-Dec-13 UK Annual All Property Total Return 350 450 40031-Dec-08 31-Dec-14 UK Annual All Property Total Return 425 525 475

Source: Tullet Prebon (TPPR)

OTC >> Futures Starting Index as at 31 Dec 08 1178.073

OTC Swap Period

Mid Quote

bpsYear

FractionDiscount Factor

SumProdYear+Df

Gross Mid TR

Projected Calendar Mid TR

Projected Index Level

Fair Futures

MidDec-08 Dec-09 -1500 1 0.988413 0.988413 -1482.62 -15.00% 1001.362 85.00 Dec-08 Dec-10 -500 1 0.963605 1.952018 -976.009 5.26% 1054.008 105.26 Dec-08 Dec-11 0 1 0.925296 2.877315 0 10.55% 1165.186 110.55 Dec-08 Dec-12 250 1.00274 0.884754 3.764492 941.123 10.64% 1289.128 110.64 Dec-08 Dec-13 400 1 0.844457 4.608949 1843.579 10.69% 1426.895 110.69 Dec-08 Dec-14 475 1 0.806401 5.41535 2572.291 9.04% 1555.838 109.04

Futures Prices > OTC PricesIPD® Property Index Futures Prices

IPD Calendar Period Futures Input PriceBeginning Ending Expiry Bid Ask Mid31-Dec-08 31-Dec-09 Mar-10 85.00 86.00 85.50 31-Dec-09 31-Dec-10 Mar-11 103.00 104.00 103.50 31-Dec-10 31-Dec-11 Mar-12 108.00 112.00 110.00 31-Dec-11 31-Dec-12 Mar-13 112.00 114.00 113.00 31-Dec-12 31-Dec-13 Mar-14 114.00 115.00 114.50

Futures Prices > OTC PricesIPD® Property Index Futures Prices

IPD Calendar Period Futures Input PriceBeginning Ending Expiry Bid Ask Mid31-Dec-08 31-Dec-09 Mar-10 85.00 86.00 85.50 31-Dec-09 31-Dec-10 Mar-11 103.00 104.00 103.50 31-Dec-10 31-Dec-11 Mar-12 108.00 112.00 110.00 31-Dec-11 31-Dec-12 Mar-13 112.00 114.00 113.00 31-Dec-12 31-Dec-13 Mar-14 114.00 115.00 114.50

Futures >> OTC 1178.0732 Starting Index as at 31 Dec 08

OTC Calendar Period Futures

Prices Mid Projected Index Level

Projected Annual TR

Year Fraction

Discount Factor

SumProdYear+Df

Discounted Property Leg

OTC Term Swap Equivalent

31-Dec-08 31-Dec-09 85.50 1007.2526 -14.50% 1 0.988413 0.988413 -14.33% -14.50%31-Dec-09 31-Dec-10 103.50 1042.5064 3.50% 1 0.963605 1.952018 -10.96% -5.61%31-Dec-10 31-Dec-11 110.00 1146.7571 10.00% 1 0.925296 2.877315 -1.71% -0.59%31-Dec-11 31-Dec-12 113.00 1295.8355 13.00% 1.00274 0.884754 3.764492 9.80% 2.60%31-Dec-12 31-Dec-13 114.50 1483.7317 14.50% 1 0.844457 4.608949 22.04% 4.78%

Futures Prices v OTC Prices

IPD® Property Index Futures Prices > OTC OTC Equivalent PricesIPD Calendar Period Futures Index Projections Input Price Fixed Spreads (bps)

Beginning Ending Expiry 1178.073 1178.073 1178.073 Bid Ask Mid Bid Ask Mid31-Dec-08 31-Dec-09 Mar-10 1001.362 1013.143 1007.253 85.00 86.00 85.5 -1500 -1400 -145031-Dec-09 31-Dec-10 Mar-11 1031.403 1053.669 1042.506 103.00 104.00 103.5 -611 -511 -56131-Dec-10 31-Dec-11 Mar-12 1113.915 1180.109 1146.757 108.00 112.00 110 -158 39 -5931-Dec-11 31-Dec-12 Mar-13 1247.585 1345.324 1295.836 112.00 114.00 113 162 359 26031-Dec-12 31-Dec-13 Mar-14 1422.247 1547.123 1483.732 114.00 115.00 114.5 389 568 478

OTC Total Return Swap Property Derivative Prices > Futures IPD® Property FuturesPeriod Fixed Leg (bps) Price

Beginning Ending Country Frequency Sector Returns Bid Ask Mid Bid Ask Mid31-Dec-08 31-Dec-09 UK Annual All Prop TR -1550 -1450 -1500 84.50 85.50 85.00 31-Dec-08 31-Dec-10 UK Annual All Prop TR -550 -450 -500 104.75 105.75 105.2531-Dec-08 31-Dec-11 UK Annual All Prop TR -50 50 0 110.05 111.05 110.5531-Dec-08 31-Dec-12 UK Annual All Prop TR 200 300 250 110.15 111.15 110.6531-Dec-08 31-Dec-13 UK Annual All Prop TR 350 450 400 110.20 111.20 110.70






Significant Divergence?






Or Illiquid Markets?

Applications 1. > Replication of TRS

IPD® UK Annual All Property Total Return Swap

Trade Date 30/06/2009

Receive Property Asset Pay Finance LegNotional 5,000,000 GBP Notional 5,000,000 GBPTerm 4 Years Term 4 YearsMaturity Date 31/12/2012 Maturity Date 31/12/2012Effective Date 31/12/2008 Effective Date 31/12/2008Reference Index IPD UK A ALL PROP Coupon 2.50% paPayment Frequency Annual Payment Frequency Annual

Basis Bond Equivalent


Property Total Return Swaps - CashflowsProperty Leg Annual (Mid) ReceiveEffective Date Pay Date Total Return Amount DiscFact 470,561.52 31-Dec-0831-Dec-09 31-Mar-10 -15.000% 750,000.00- 0.98841 741,310.07- 31-Dec-10 31-Mar-11 5.257% 262,872.89 0.96360 253,305.55 31-Dec-11 30-Mar-12 10.548% 527,403.43 0.92530 488,004.52 31-Dec-12 28-Mar-13 10.637% 531,855.99 0.88475 470,561.52

470,561.52

Fixed Leg PayDate Pay Date Coupon Amount DiscFact 470,561.52- 31-Dec-0831-Dec-09 31-Mar-10 2.50% 125,000.00- 0.98841 123,551.68- 31-Dec-10 31-Mar-11 2.50% 125,000.00- 0.96360 120,450.58- 31-Dec-11 30-Mar-12 2.50% 125,000.00- 0.92530 115,662.06- 31-Dec-12 28-Mar-13 2.50% 125,342.47- 0.88475 110,897.20-

470,561.52-


OTC Swap Period

Mid Quote

bpsYear

FractionDiscount Factor

SumProdYear+Df

Gross Mid TR

Projected Calendar Mid TR

Projected Index Level

Fair Futures

MidDec-08 Dec-09 -1500 1 0.988413 0.988413 -1482.62 -15.000% 1001.362 85.00 Dec-08 Dec-10 -500 1 0.963605 1.952018 -976.009 5.257% 1054.008 105.26 Dec-08 Dec-11 0 1 0.925296 2.877315 0 10.548% 1165.186 110.55 Dec-08 Dec-12 250 1.00274 0.884754 3.764492 941.123 10.637% 1289.128 110.64

Futures Contract Strip EquivalentExpiry Buy/Sell Contracts Price Reval P&L

31-Mar-10 BUY 98.84 85.00 85.00 - 31-Mar-11 BUY 96.36 105.26 105.26 - 30-Mar-12 BUY 92.53 110.55 110.55 - 28-Mar-13 BUY 88.48 110.64 110.64 -

Applications 1a. > Replication of Notes

£10 million 4 year Note:

Purchase £9.3m face of UK Gilts 4½ Mar-13 @ 106.00 (yields 2.774%)

Purchase Futures Strip above 753 contracts at average price 102.50

Initial Margin of 5.4% x 753 contracts x £ 50,000 notional = £2.033m

Deposit Collateral £2.096m wit Eurex Clearing via General Clearing Member (UK Gilts are Accepted Collateral at Eurex Clearing with a 3% haircut)

Returns on £10 m = 2.774% p.a. +/- (IPD Total Returns – 2.5% pa.)

Futures Contract Strip EquivalentExpiry Buy/Sell Contracts Price Reval P&L

31-Mar-10 BUY 198 85.00 85.00 - 31-Mar-11 BUY 193 105.26 105.26 - 30-Mar-12 BUY 185 110.55 110.55 - 28-Mar-13 BUY 177 110.64 110.64 -

Eurex Clearing AG: the Central Counterparty

Applications 2. > Calendar SpreadsCalendar Curve

82.25

103

110111.75

116.05

78

88

98

108

118

Cal 09 Cal 10 Cal 11 Cal 12 Cal 13

Contract Expiry

Futu

res

Pric

e

4-May

Calendar Curve

82.25

103

110111.75

116.05

78

88

98

108

118


Contract Expiry

Futu

res

Pric

e

4-May

Applications 2. > Calendar Spreads

oversold

overbought

pivot


116.05

82.25

114.5

85.5

78

88

98

108

118


Contract Expiry

Futu

res

Pric

e

4-May

24-Jun


116.05

82.25

114.5

85.5

78

88

98

108

118


Contract Expiry

Futu

res

Pric

e

4-May

24-Jun

up 3.25 pts / 65 ticks / £1,625

down 1.55 pts / 31 ticks / £775

Applications > Relative Value Positioning

Implied yield UK majors IPD spot Yield (May) Implied IPD forward swaps/futures

7.76% 7.8% 8.26%

AAA CMBS trading prices CMBS Implied falls in value of real estate from Dec08

Implied fall in capital value in IPD from Dec08

70% 50-60% 28%

Relative Value Positioning – Across Property Assets1. UK REITS v IPD Synthetic

● Sell Listed Equity v Buy IPD

2. CMBS v IPD Synthetic

● Buy CMBS versus Sell IPD

3. Capital Value Structure

● Buy Equity & Debt versus Sell IPD

Strategy Ideas - courtesy of REECH Aim

Implied Real Estate Cost (Debt + Equity ) IPD forwards – Cal 2011/2012/2013

80% +10%

Applications > Property Derivatives Portfolio Ramp Up

Allocate (expected) Funds to BUY immediate synthetic exposure now –reduce synthetic exposure when direct assets are identified and addedManage redemptions by selling synthetic exposure and unwinding on asset disposals

Hedging Sell (short) synthetic exposure to protect value of prime/core assets to protect absolute returns

Portfolio Rebalancing Trade synthetic exposure intra / inter funds without incurring direct costs

Diversification/Tactical Asset AllocationTake/adjust property exposure using synthetic instruments

Instruments of Real Estate Beta Use futures to return market beta whilst re-balancing portfolios

The Regulatory ViewPAUL TUCKER,

DEPUTY GOVERNOR, FINANCIAL STABILITY, BANK OF ENGLAND

Association of British Insurers 2009 Conference London 9 June 2009

“…the Bank of England agrees that more of the vanilla OTC markets should be cleared via central counterparty clearing houses.”

“Central clearing can help to provide transparency and consistency in valuations and haircuts.”

“The financial community must also be open to more trading in core, vanilla markets going via exchanges or other well-designed and open trading platforms. If well constructed, that could help to preserve liquidity when times are tough.”

© Eurex 2008Deutsche Börse AG (DBAG), Eurex Frankfurt AG, Eurex Clearing AG (Eurex Clearing) as well as Eurex Bonds GmbH (Eurex Bonds) and Eurex Repo GmbH (Eurex Repo) are corporate entities and are registered under German law. Eurex Zürich AG is a corporate entity and is registered under Swiss law. U.S. Exchange Holdings, Inc. and International Securities Exchange Holdings, Inc. (ISE) are corporate entities and are registered under U.S. American law. EurexFrankfurt AG (Eurex) is the administrating and operating institution of Eurex Deutschland. Eurex Deutschland and Eurex Zürich AG are in the following referred to as the “Eurex Exchanges”. All intellectual property, proprietary and other rights and interests in this publication and the subject matter hereof (other than certain trademarks and service marks listed below) are owned by DBAG and its affiliates and subsidiaries including, without limitation, all patent, registered design, copyright, trademark and service mark rights. While reasonable care has been taken in the preparation of this publication to provide details that are accurate and not misleading at the time of publication DBAG, Eurex, Eurex Bonds, Eurex Repo, the Eurex Exchanges and Eurex Clearing and their respective servants and agents (a) do not make any representations or warranties regarding the information contained herein, whether express or implied, including without limitation any implied warranty of merchantability or fitness for a particular purpose or any warranty with respect to the accuracy, correctness, quality, completeness or timeliness of such information, and (b) shall not be responsible or liable for any third party’s use of any information contained herein under any circumstances, including, without limitation, in connection with actual trading or otherwise or for any errors or omissions contained in this publication. This publication is published for information purposes only and shall not constitute investment advice respectively does not constitute an offer, solicitation or recommendation to acquire or dispose of any investment or to engage in any other transaction. This publication is not intended for solicitation purposes but only for use as general information. All descriptions, examples and calculations contained in this publication are for illustrative purposes only.Eurex offers services directly to members of the Eurex exchanges. Those who desire to trade any products available on the Eurex market or who desire to offer and sell any such products to others, should consider legal and regulatory requirements of those jurisdictions relevant to them, as well as the risks associated with such products, before doing so.Eurex derivatives (other than Dow Jones EURO STOXX 50® Index Futures contracts, Dow Jones STOXX 50® Index Futures contracts, Dow Jones STOXX® 600 Index Futures contracts, Dow Jones STOXX® Large/Mid/Small 200 Index Futures contracts, Dow Jones EURO STOXX® Banks Futures contracts, Dow Jones STOXX® 600 Banks/Industrial Goods & Services/Insurance/Media/Personal & Household Goods/Travel & Leisure/Utilities Futures contracts, Dow Jones Global Titans 50SM Index Futures contracts, DAX® Futures contracts, MDAX® Futures contracts, Eurex inflation derivatives, and Eurex interest rate derivatives) are currently not available for offer, sale or trading in the United States or by United States persons.

Trademarks and Service MarksBuxl®, DAX®, DivDAX®, eb.rexx®, Eurex®, Eurex Bonds®, Eurex Repo®, Euro GC Pooling®, Eurex Strategy WizardSM, FDAX®, FWB®, MDAX®, TecDAX®, VDAX®, VDAX-NEW®, Xetra® and XTF Exchange Traded Funds® are registered trademarks of DBAG. The service mark MSCI Russia is the exclusive property of Morgan Stanley Capital International, Inc.RDXxt® is a registered trademark of Wiener Börse AG (Vienna Stock Exchange).iTraxx® is a registered trademark of International Index Company Limited (IIC) and has been licensed for the use by Eurex. IIC does not approve, endorse or recommend Eurex or iTraxx® Europe 5-year Index Futures, iTraxx® Europe HiVol 5-year Index Futures and iTraxx® Europe Crossover 5-year Index Futures.Eurex is solely responsible for the creation of the Eurex iTraxx® Credit Futures contracts, their trading and market surveillance. ISDA® neither sponsors nor endorses the product’s use. ISDA® is a registered trademark of the International Swaps and Derivatives Association, Inc.SLI®, SMI®, SMIM®, SPI® and VSMI® are registered trademarks of SWX Swiss Exchange. STOXX®, Dow Jones STOXX® 600 Index, Dow Jones STOXX® Large 200 Index, Dow Jones STOXX® Mid 200 Index, Dow Jones STOXX® Small 200 Index, Dow Jones STOXX® TMI Index, VSTOXX® Index, Dow Jones EURO STOXX® Select Dividend 30 Index, Dow Jones EURO STOXX®/STOXX® 600 Sector Indexes as well as the Dow Jones EURO STOXX 50® Index and Dow Jones STOXX 50® Index are service marks of STOXX Ltd. and/or Dow Jones & Company, Inc.Dow Jones and Dow Jones Global Titans 50SM Index are service marks of Dow Jones & Company, Inc. The derivatives based on these indexes are not sponsored, endorsed, sold or promoted by STOXX Ltd. or Dow Jones & Company, Inc., and neither party makes any representation regarding the advisability of trading or of investing in such products.The names of other companies and third party products may be trademarks or service marks of their respective owners.


Q&A Session

Property Derivatives: What’s in the Pricing? What’s

in the Future?


Thursday 2nd July 2009


Panel• Christophe Cuny

– Director: Property Derivatives, Eurohypo

• Colin Lizieri– Professor of Real Estate Finance; Director of Research for Real Estate

& Planning, Henley Business School, University of Reading

• Stuart Heath– Director: Product Strategy, Eurex

• Robert Fourt– Partner: Planning & Development and Structured Finance, Gerald Eve



BiographiesIain ReidChief Executive Officer and Chief Investment Officer, Protego Real Estate Investors LLP

Iain Reid is a founder of Protego Real Estate Investors LLP and a Fellow of the Royal Institution of Chartered Surveyors. He was previously Chief Executive of a successful Pan European property investment management subsidiary of a publicly quoted asset management company which he grew between 2001 and 2003 from €2bn AUM to €10bn AUM, through organic growth as well as acquisitions. This company had 45 separate account clients and 25 fund investors in its institutional client base. Over the preceding period since 1993, at which time Iain joined the Barclay's Bank Group, he transformed an internal Barclay's property investment service operation into a third party business, adding numerous blue chip clients and doubling AUM in the process. Iain was also Chief Investment Officer of the company from 1993 to 2001. Over this time, Iain created a personal and corporate reputation for groundbreaking innovations in the property sector. In particular, he was responsible for creating Property Index Certificates (a bond structure), Property Index Forwards and some of the first private institutional co-investment vehicles in the UK. In the period from 1986 to 1992, Iain was International Head of Research at Richard Ellis, Property Consultants, where he was responsible for developing the service to investors including one of the first property return forecasting systems and the creation of the UK's first monthly index of the property market. This became a substantial consulting business. Up to 1986 Iain was the Managing Partner of Richard Ellis' UK Investment Management Division. Iain chairs Protego’s investment committee. He is a member and former Chairman of the IPF's Property Derivatives Interest Group; a member of the all-asset class UK Investment Performance Council; the NAPF's Property Investment Sub-Committee and the IPD Index Consultative Group.


BiographiesChristophe Cuny - Director: Property Derivatives, Eurohypo

Christophe Cuny joined Eurohypo in September 2008 to originate and structure Property Derivatives solutions for Eurohypo clients. He is one of the pioneers of this relatively new market. Prior to joining Eurohypo, Christophe was responsible for Property Derivatives structuring and marketing at ABN AMRO. He has also consulted on alternative investments (Hedge Funds, Private Equity and Zero-Betas) and was responsible for the development of the then embryonic inflation derivatives at Abbey. Christophe holds an MBA from Cass (City University) Business School.

Colin Lizieri - Professor of Real Estate Finance; Director of Research for Real Estate & Planning, Henley Business School, University of ReadingColin is Professor of Real Estate Finance in the School of Real Estate & Planning at the University of Reading’s Henley Business School. He is director of Research for Real Estate & Planning and served as Head of Department. Colin has worked in real estate for nearly thirty years. His principal research covers modelling of real estate investment, global office markets and international real estate. He has carried out research and consultancy for the European Union, the Norwegian government, Her Majesty’s Treasury, the Department of Communities and Local Government, the Home Office and a wide range of public and private sector clients including PREA, the RICS and IPF and appeared as an expert witness in the Lands Tribunal. He led the Investment Property Forum research projects on commercial property market liquidity and on the pricing of property derivatives. He has published widely in academic and professional journals, with over 100 publications and is the author of Towers of Capital and co-author of The Economics of Commercial Property Markets. He has been asked to present research and lecture in over thirty countries. In 2004 he was awarded the International Real Estate Society achievement award “for outstanding achievement in real estate research, education and practice at the international level” and in 2005 elected an honorary fellow of the Society of Property Researchers “in recognition of an outstanding contribution in the field of property research”.


BiographiesStuart Heath – Director: Product Strategy, Eurex

Stuart Heath is responsible for the introduction of new asset classes to Eurex, one of the world's largest futures and options exchange and Europe's biggest clearing house. Stuart has spent the last two years working on the launch of property index futures which were introduced with the IPD All Property UK Annual Index futures in February 2009. Prior to joining Eurex in 2007 Stuart worked for 15 years in the financial industry, initially in a risk management role but more recently in a derivatives trading role at institutions such as RBS & Daiwa. Stuart has an MSc in International Banking & Finance from Heriot Watt University and a BA (Hons) in Accounting & Finance.

Robert Fourt - Partner: Planning & Development and Structured Finance, Gerald EveRobert is a partner in the Gerald Eve planning & development and structured finance teams, based in the West End. He has been with the firm since 1986 and, in the mid-1990s, he managed the firm’s Polish operations. He has provided advice on a variety of commercial property throughout England and on mainland Europe. Robert has specialised in the field of development consultancy and finance including project co-ordination, strategic planning, financial and risk analysis, feasibility studies and the funding and bringing forward a wide range of schemes on behalf of public, private and corporate clients. Since 2007 he has also been partner responsible for research in Gerald Eve. He has dealt with major acquisitions and disposals of real estate, a number of joint ventures, as well as land assembly and advice upon large mixed-use development schemes. Increasingly he has been asked to advise upon the risk associated with investment and development projects and how this can be quantified and managed. This has involved advising and applying various modelling techniques including VaR, simulation, real options analysis and property derivatives. Robert is a contributing author to Applied Risk Analysis (2003); Real Options Analysis (2005); and Modelling Risk (2006) published by Wiley. He was also invited to present a paper on Investment Holding Periods at the 2005 IPD/IPF conference. Robert also presented papers on UK real estate volatility and real options at the 2006 and 2007 European Real Estate Society conferences. He also oversees the firm's quarterly Investment Brief publication. Robert is an experienced expert witness who has provided evidence upon valuation, financial, viability, and development matters at various public inquiries and in the High Court. In addition Robert provides advice on financial viability in respect of affordable housing provision and planning obligations within schemes utilising both bespoke and the GLA Development Control Toolkit – also known as the ‘Three Dragons’ model.

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