Exhibit 4

FAS 138 Benchmark Interest Value-Locked Debt Accounting Case:
Glossary of Key Terms

Bob Jensen at Trinity University

This is a very small subset of Bob Jensen's large FAS 133 and IAS 39 Glossary.  That large Glossary can be accessed at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm

Benchmark Interest Rate =

FAS 138 Amendments expand the eligibility of many derivative instrument hedges to qualify FAS 133/138 hedge. Such qualifications in accounting treatment that reduces earnings volatility when the derivatives are adjusted for fair value. 

The term "swap spread" applies to the credit component of interest rate risk.  Assume a U.S. Treasury bill rate is a  risk-free rate.  You can read the following at http://www.cbot.com/ourproducts/financial/agencystrat3rd.html 

The swap spread represents the credit risk in the swap relative to the corresponding risk-free Treasury yield. It is the price tag on the actuarial risk that one of the parties to the swap will fail to make a payment. The Treasury yield provides the foundation in computing this spread, because the U.S. Treasury is a risk-free borrower. It does not default on its interest payments.

Since the swap rate is the sum of the Treasury yield and the swap spread, a well-known statistical rule breaks its volatility into three components:

Swap Rate Variance = Treasury Yield Variance
                                    + Swap Spread Variance
                                    + 2 x Covariance of Treasury Yield and Swap Spread

Taken over long time spans (e.g., quarter-to-quarter or annual), changes in the 10-year swap spread exhibit a small but reliably positive covariance with changes in the 10-year Treasury yield. For practical purposes this means that as Treasury yield levels rise and fall over, say, the course of the business cycle, the credit risk in interest rate swaps tends to rise and fall with them.

However as Figure 1 illustrates, high-frequency (e.g., day-to-day or week-to-week) moves in swap spreads and Treasury yields tend to be uncorrelated. Their covariance is close to zero. Thus, for holding periods that cover very short time spans, this stylized fact allows simplification of the preceding formula into the following approximation:

 

This rule of thumb allows attribution of the variability in swap rates in ways that are useful for hedgers. For example, during the five years from 1993 through 1997, 99% of week-to-week variability in 10-year swap rates derived from variability in the 10-year Treasury yield. Variability in the 10-year swap spread accounted for just 1%.

It is very popular in practice to have a hedging instrument and the hedged item be based upon two different indices.  In particular, the hedged item may be impacted by credit factors.  For example, interest rates commonly viewed as having three components noted below:

·        Risk-free risk that the level of interest rates in risk-free financial instruments such as U.S. treasury T-bill rates will vary system-side over time.

·        Credit sector spread risk that interest rates for particular economic sectors will vary over and above the risk-free interest rate movements.  For example, when automobiles replaced horses as the primary means of open road transportation, the horse industry’s credit worthiness suffered independently of other sectors of the economy.  In more recent times, the dot.com sector’s sector spread has suffered some setbacks.  In this case of interest rate swaps, this is the swap spread defined above.

·        Unsystematic spread risk of a particular borrower that varies over and above risk-free and credit sector spreads.  The credit of a particular firm may move independently of more system-wide (systematic) risk-free rates and sector spreads.

Suppose that a hedge only pays at the Treasury rate for hedged item based on some variable index having credit components.  FAS 133 prohibited “treasury locks” that hedged only the risk-free rates but not credit-sector spreads or unsystematic risk.  This was upsetting many firms that commonly hedge with treasury locks.  There is a market for treasury lock derivatives that is available, whereas hedges for entire interest rate risk are more difficult to obtain in practice.  It is also common to hedge with London’s LIBOR that has a spread apart from a risk-free component.

The DIG confused the issue by allowing both risk-free and credit sector spread to receive hedge accounting in its DIG Issue E1 ruling.  Paragraph 14 of FAS 138 states the following:

Comments received by the Board on Implementation Issue E1 indicated (a) that the concept of market interest rate risk as set forth in Statement 133 differed from the common understanding of interest rate risk by market participants, (b) that the guidance in the Implementation Issue was inconsistent with present hedging activities, and (c) that measuring the change in fair value of the hedged item attributable to changes in credit sector spreads would be difficult because consistent sector spread data are not readily available in the market. 

In FAS 138, the board sought to reduce confusion by reducing all components risk into just two components called “interest rate risk” and “credit risk.”  Credit risk includes all risk other than the “benchmarked” component in a hedged item’s index.  A benchmark index can include somewhat more than movements in risk-free rates.  FAS 138 allows the popular LIBOR hedging rate that is not viewed as being entirely a risk-free rate.  Paragraph 16 introduces the concept of “benchmark interest rate” as follows:

Because the Board decided to permit a rate that is not fully risk-free to be the designated risk in a hedge of interest rate risk, it developed the general notion of benchmark interest rate to encompass both risk-free rates and rates based on the LIBOR swap curve in the United States.

FAS 133 thus allows benchmarking on LIBOR.  It is not possible to benchmark on such rates as commercial paper rates, Fed Fund rates, or FNMA par mortgage rates.

Readers might then ask what the big deal is since some of the FAS 133 examples (e.g., Example 5 beginning in Paragraph 133) hedged on the basis of LIBOR.  It is important to note that in those original examples, the hedging instrument (e.g., a swap) and the hedged item (e.g., a bond) both used LIBOR in defining a variable rate?  If the hedging instrument used LIBOR and the hedged item interest rate was based upon an index poorly correlated with LIBOR, the hedge would not qualify (prior to FAS 138) for FAS 133 hedge accounting treatment even though the derivative itself would have to be adjusted for fair value each quarter.  Recall that LIBOR is a short-term European rate that may not correlate with various interest indices in the U.S.  FAS 133 now allows a properly benchmarked hedge (e.g., a swap rate based on LIBOR or T-bills) to hedge an item having non-benchmarked components.

The short-cut method of relieving hedge ineffectiveness testing may no longer be available.  Paragraph 23 of FAS 138 states the following:

For cash flow hedges of an existing variable-rate financial asset or liability, the designated risk being hedged cannot be the risk of changes in its cash flows attributable to changes in the benchmark interest rate if the cash flows of the hedged item are explicitly based on a different index.  In those situations, because the risk of changes in the benchmark interest rate (that is, interest rate risk) cannot be the designated risk being hedged, the shortcut method cannot be applied.  The Board’s decision to require that the index on which the variable leg of the swap is based match the benchmark interest rate designated as the interest rate risk being hedged for the hedging relationship also ensures that the shortcut method is applied only to interest rate risk hedges.  The Board’s decision precludes use of the shortcut method in situations in which the cash flows of the hedged item and the hedging instrument are based on the same index but that index is not the designated benchmark interest rate.  The Board noted, however, that in some of those situations, an entity easily could determine that the hedge is perfectly effective.  The shortcut method would be permitted for cash flow hedges in situations in which the cash flows of the hedged item and the hedging instrument are based on the same index and that index is the designated benchmark interest rate.

In other words, any hedge item that is not based upon only a benchmarked component will force hedge effectiveness testing at least quarterly.  Thus FAS 138 broadened the scope of qualifying hedges, but it made the accounting more difficult by forcing more frequent effectiveness testing.

FAS 138 also permits the hedge derivative to have more risk than the hedged item.  For example, a LIBOR-based interest rate swap might be used to hedge an AAA corporate bond or even a note rate based upon T-Bills.

There are restrictions noted in Paragraph 24 of FAS 138:

This Statement provides limited guidance on how the change in a hedged item’s fair value attributable to changes in the designated benchmark interest rate should be determined.  The Board decided that in calculating the change in the hedged item’s fair value attributable to changes in the designated benchmark interest rate, the estimated cash flows used must be based on all of the contractual cash flows of the entire hedged item.  That guidance does not mandate the use of any one method, but it precludes the use of a method that excludes some of the hedged item’s contractual cash flows (such as the portion of interest payments attributable to the obligor’s credit risk above the benchmark rate) from the calculation.  The Board concluded that excluding some of the hedged item’s contractual cash flows would introduce a new approach to bifurcation of a hedged item that does not currently exist in the Statement 133 hedging model.

The FASB provides some new examples illustrating the FAS 138 Amendments to FAS 133 at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html
Example 1 on interest rate benchmarking begins as follows:

Example: Fair Value Hedge of the LIBOR Swap Rate in a $100 Million A1-Quality 5-Year Fixed-Rate Noncallable Debt On April 3, 20X0, Global Tech issues at par a $100 million A1-quality 5-year fixed-rate noncallable debt instrument with an annual 8 percent interest coupon payable semiannually. On that date, Global Tech enters into a 5-year interest rate swap based on the LIBOR swap rate and designates it as the hedging instrument in a fair value hedge of the $100 million liability. Under the terms of the swap, Global Tech will receive a fixed interest rate at 8 percent and pay variable interest at LIBOR plus 78.5 basis points (current LIBOR 6.29%) on a notional amount of $101,970,000 (semiannual settlement and interest reset dates). A duration-weighted hedge ratio was used to calculate the notional amount of the swap necessary to offset the debt's fair value changes attributable to changes in the LIBOR swap rate.