From: Daniel Sabba

From: Daniel Sabba To: [email protected] Cc: Paul Morris , Vahe Ste anian , Tazia Smith Subject: Hi Jeffrey - follow-up on options for rates steepness in USD [C] Date: Tue, 14 Oct 2014 19:44:12 +0000 Inline-Images: unnamed; unnamed(I); unnamed(2); unnamed(3); unnamed(4); unnamed(5) Classification: Confidential Jeffrey, It was a pleasure to talk today and looking forward to meeting when you get back to NY. Please see below for the rationale of the 5s10s steepener trade - I just repriced this for USD lbn notional. As discussed, you pay 15bps upfront for an at-the- money-forward (ATMF) CMS option struck at 54.5bps. The current spot is at 71bps, so it is 16.5bps above the ATMF strike. Last week, before the FOMC minutes were released, the spot was 20bps above the ATMF strike level. The current roll is not as high as last week but, it still represents very cheap optionality which carries roll benefit and unlimited upside in the event of curve steepening at expiry. Purchase options on USD curve steepness (CMS 5slOs ATMF curve caps) USD curve steepness close to 5 year lows: 140 130 120 110 100 90 80 70 60 ' a U 10/07/0, 14/47/10 10/07/11 10/07/12 10/07/13 10/07/14 Indicative terms: Notional USD 1bn Client buys CMS curve cap on 5s10s in USD Expiry 1 year CMS 5s10s Strike ATMF (54.5bps) CMS 5s10s Spot 71bps Upfront premium offer (mid): 15bps (13.5bps) Terminal Payout: Notional*Max (CMS 5s10s Terminal Rate-Strike, 0) Settlement: Cash Trade Rationale and Implementation: • Potential catalysts for steepening in the short term frame include: o Economic recovery and a pick up in inflation expectations, which are likely to sustainably price a Fed tightening cycle o Conversely, given inflation breakevens are currently depressed, if a negative could imply a more accommodative Fed, which is commonly associated with o Deutsche Bank research on total return bond fund returns and rates derivate steepeners are less crowded among real money investors be a prerequisite for the market to economic shock were to happen, it a steeper curve positioning suggests US EFTA01145686 • While a steepening view can be articulated in various delta-one ways, CMS curve caps allow clients to express a steepening view with limited downside, where the maximum downside is the premium paid. The terminal payout is NotionarMax(Terminal Rate-Strike,0) • Because forwards are currently inverted, clients are able to purchase options with a higher positive roll from forwards to spot than the premium initially paid Overview on current market dynamics: This year's USD interest rate curve flattening in 5s10s can be decomposed into three distinct phases: (i) the market repricing Fed tapering in the 10y sector (ii) China's intervention on USDCNY, building up official foreign reserves (iii) increase of deflation and QE expectations out of Europe Hypothetical PnL at Expiry 100.00 80.00 60.00 40.00 20.00 0.00 -20.00 a . Loss (anentCMS5510s Leah at 71bPS OAS5s10s et DOI. lest Nola 80 100 120 140 One 1y10y/10y swap rate vs. 1y5y/5y swap rate (as of 1010712014) 1.6 1.5 1.4 1.3 1.2 1.1 1 Jul-09 Nov-10 Apr-12 Aug-13 Dec -14 Positioning research suggests steepeners are less crowded among real money investors 0.03% 0.03% 0.02% 0.02% 001% 001% 0.00% -0.01% -0.01% -0.02% Mar-12 US real money Mope perarboning 0'0 steepeoers. <0 f1304~10 Crowded flattonors ahead of QE tapering announcement and - - - - 1 bear steepening regime Sop•12 Mar-13 Sop-13 Crowded steepeners in 04 2013 ahead of flattening regtmo in I41 2014 Mar-14 Sep-14 (DB GM Research: Global Fixed Income Weekly — 10/03/14) Please note all prices are indicative and subject to change without notice. EFTA01145687 Best regards, Daniel Daniel Sabba Director I Key Client Partners Deutsche Bank Securities Inc Deutsche Asset S Wealth Management 345 Park Avenue, 26th Floor Nev Tel. 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