Preservation of capital or return: an unavoidable choice?

May 2006

Justo de RufinoBBVA Mercados Globales y DistribuciónDirector Negocio Crédito

P. 2

Product descriptionStructured Products

Investors seek

Products with guaranteed capital

Maximization of the Yield/Volatility Maximization of the Yield/Volatility RatioRatio

P. 3

Product descriptionStructured Products

Structuring ability

Maximum flexibility to meet client needs

Structured productsStructured products with with guaranteed capital guaranteed capital

P. 4

Product descriptionStructured Products

The client receives the yield by means of:

+Annual/Quarterly Coupons (Fixed or

floating)

100% Dynamic Management

100% Protected Capital

Structured ProductsStructured Products

P. 5

Product descriptionStructured Products

Annual/Quarterly Coupons Notes with

guaranteed capital

linked to CDX

Structured Structured products with products with

guaranteed guaranteed capital capital

Format

Dynamic Management of

Basket of Funds

(CPPI)

Flexibilityto meet

client needs

100% Protected

Capital

Dynamic ManagementInstitutional

Tier I Bonds(PPN)

P. 6

FormatStructured Products

Format Structured products may have the following format:

Format: Notes Issued by SPV, Issuer, Deposit, Swap, etc

Term: 7/10 years

Protected Principal: 100%

P. 7

CouponsStructured Products

Annual/QuarterlyCoupons

The product pays coupons annually or quarterly, either guaranteed or subject to the existence of a cushion in the structure:

Floating

Fixed

Benchmarked to some index, etc

P. 8

Dynamic management of CPPIStructured Products

Dynamic Management of

Basket of Funds

(CPPI)

Dynamic management is introduced into the structure, applying the CPPI technique (see section II for further details)

The underlying asset, dynamically managed, will be a basket of funds, chosen by means of a quantitative analysis, seeking to maximise the yield/risk binomial.

Research will be carried out with the aim of obtaining an asset with high yield, accompanied by very low volatility, thanks to the optimization achieved by the study of correlations between the components of the basket

By dynamic management, leverage, in addition to guaranteeing the nominal value, allows the share in the rise of the underlying asset to be over 100%

P. 9

Underlying Asset

Dynamic Management of CPPIStructured Products

DynamicManagement of

Basket Of Funds

(CPPI)

The asset underlying the CPPI will be a balanced, consistent basket of funds from the yield/risk ratio point of view.

We need to imagine a basket selected from among the following categories, with a track record showing an excellent level of yield/risk and a study of the basket’s correlation, sensitivity and trade-off which guarantees balance and diversification:

Global Fixed Income

US Fixed Income

Global Equities

Latam Equities

P. 10

Simulations

Dynamic Management of CPPIStructured Products

DynamicManagement of

Basket Of Funds

(CPPI)

Dynamic Management Simulation : we have carried out 1000 Monte Carlo Simulations using the following scenario:

• Funding: 1M USD Libor forward.

• Maximum Investment in the Underlying Basket of Funds: 300%.

• Maximum Monthly Fall permitted: 10% (Leverage: 10 times the cushion).

• Initial Cushion: [15.00]%.

• Initial Investment: [150.00]%.

• Coupon zero fixed at the outset to protect the capital.

• Yield and Volatility of the Basket for carrying out the Monte Carlo simulations exactly as indicated in the Track Record:

- IRR: 12.45%.- Volatility: 4.89%.

P. 11

Simulations

Dynamic Management of CPPI Structured Products

DynamicManagement of

Basket Of Funds

(CPPI)

According to the 1000 Monte Carlo Simulations that were carried out and the distribution of probabilities of the IRR of the CPPI over the nominal value of the notes, statistically:

• The average expected IRR of the CPPI is

16.69%

• The IRR of the CPPI will be over 10.52% with a 95% probability

• The IRR of the CPPI will be over 7.61% with a 98% probability

P. 12

Yield Distribution Probability of the CPPI

2.00% 1.90%

6.20%

16.70%

28.20%

41.70%

3.30%0.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

7.56% 10.01% 12.45% 14.90% 17.34% 22.23% 27.12% 32.01%

2.67% 7.56% 10.01% 12.45% 14.90% 17.34% 22.23% 27.12%

Yield

Pro

bab

ility

Simulations

Dynamic Management of CPPI Structured Products

DynamicManagement of

Basket Of Funds

(CPPI)

Percentile 95: IRR 10.52%

Percentile 98: IRR 7.61%

Average IRR 16.69%

Distribution of probabilities of the expected CPPI yield, to which must be added the yield received as a result of payment of guaranteed coupons, which in this case are annual coupons at 2.50%

P. 13

Characteristics

Notes with guaranteed capital linked to CDXStructured Products

Notes withguaranteed

capital linked to CDX

Notes with guaranteed principal

Minimum coupon guaranteed

Additional coupon, linked to possible credit events in

the 0% - 3% tranche of the CDX index.

Final Accumulated Super Coupon, linked to

possible credit events in the 0% - 3% tranche of the CDX index.

P. 14

Notes with guaranteed capital linked to CDX Structured Products

Standard and liquid credit index (CDS)

Consisting of 125 references of US Investment Grade

Wide diversification by sector

0 – 3% Tranche: Equity Tranche of the CDX Index

Absorbs the first losses up to a limit of 3% of the portfolio (CDX)

0 – 3% Tranche

CDX Index

P. 15

Notes with guaranteed capital linked to CDX Structured Products

Structure

Throughout the life of the Note the Investor receives:

+ Guaranteed Coupon

+ Variable Coupon (linked to defaults in the 0% - 3% tranche of CDX)

Risk-freeAsset

Credit exposure

100% Capital

Super Coupon

Investment in CDX 0-3%

Investment in risk-free asset

At term the investor receives:

+ K Guaranteed

+ Super Coupon (linked to defaults in 0% - 3% CDX)

P. 16

Notes with guaranteed capital linked to CDXStructured Products

During 10 years the investor receives:

A minimum guaranteed coupon

A credit-linked coupon

At term he receives:

100% of his guaranteed investment.

A Final Super Coupon, also credit-linked.

Note at 10 years

Flow structure

Credit-linked CouponGuaranteed Coupon

10 years

Final Super CouponGuaranteed Principal

P. 17

Notes with guaranteed capital linked to CDXStructured Products

Term : 10 years

Currency: USD

Minimum guaranteed coupon: 2.43%

Fixed coupon linked to CDX 0-3% : 3.94%

Final Premium Coupon linked to CDX 0-3% : 39.05%

IRR (in case of no defaults): 9.11%

Example

Flow Structure

Number of defaults Guaranteed Coupon C.Linked Coupon Premium Coupon

0 2.43% 3.94% 39.05%1 2.43% 3.41% 33.84%2 2.43% 2.89% 28.64%3 2.43% 2.36% 23.43%4 2.43% 1.84% 18.22%5 2.43% 1.31% 13.02%6 2.43% 0.79% 7.81%7 2.43% 0.26% 2.60%8 2.43% 0.00% 0.00%

Estimated Recovery Rate: 50%

P. 18

Dynamic Management of Principal Protected Note (PPN)

Structured Products

DynamicManagementInstitutional

Tier 1Bonds(PPN)

Format: Notes (PPN) issued by SPV

Dynamic Management: initial exposure of 250% of the nominal value issued in a bond portfolio made up of Institutional Tier 1 securities

A system of Triggers is set up, in other words, exposure and cushion limits that force disinvestment if the cushion descends to the level below. If it returns to the upper level, reinvestment takes place but never exceeding an exposure of 250% on the basket

P. 19

Portfolio

Structured Products

DynamicManagementInstitutional

Tier 1Bonds(PPN)

The underlying bond portfolio may have the following characteristics

Institutional Tier I securities

Basket made up of 20 references

Each bond in Asset Swap until the first Call date

Issuers with a credit rating between AAA y A+

Dynamic Management of Principal Protected Note (PPN)

P. 20

Substitution Event

Structured Products

DynamicManagementInstitutional

Tier 1Bonds(PPN)

In case of the call being exercised on any bond by the issuer, or the rating of the issuer itself falling below Investment Grade, BBVA shall be able to substitute the bond(s) in question within the portfolio to protect the structure.

In such a case, the substituting bond shall be similar to the one being substituted and come from an issuer of the same rating or higher than that originally held by the issuer of the substituted bond in the structure.

Dynamic Management of Principal Protected Note (PPN)

P. 21

Simulations

Structured Products

DynamicManagementInstitutional

Tier 1Bonds(PPN)

Dynamic Management Simulation:

Funding: 1M Euribor forward

Maximum Investment (Equal to the Initial Investment): 250%

Initial Cushion: [30.93]%

Open Coupon Zero

Quarterly Coupons: Euribor 3m + 20pb

Scenario presented:

At current market levels, the carry of the underlying bond portfolio is:

Euribor 1M + 65.00pb

Carry (net of fees) of the leveraged underlying bond portfolio:

Euribor 1M + 112.50pb

Dynamic Management of Principal Protected Note (PPN)

P. 22

Simulations

Structured Products

DynamicManagementInstitutional

Tier 1Bonds(PPN)

Result of the simulation:

IRR: 5.61% (quarterly coupons of de Euribor 3m + 20pb included in the calculation and net of fees)

This IRR would improve if:

There were a rise in interest rates, because the return received by the client is at a floating rate and this would also make the product more consistent, avoiding the likelihood of a partial or total Trigger Event.

There were an improvement in the price of the bonds in the underlying portfolio.

Dynamic Management of Principal Protected Note (PPN)