US Macroeconomic Outlook,
Funding Strategies,
and a Sixty-Year History of Markets
By Niso Abuaf
July 2013
1.
US Macroeconomic Outlook
2.
Efficient-Frontier Funding Strategies
3.
A Sixty-Year History of Interest Rates
4.
History of Economic Growth: GDP and the Stock
Market
Page 2
Executive Summary
The US Macro Outlook and Efficient Funding Strategies





The current macroeconomic outlook presents a duality: exceedingly low short-term interest rates in the medium term, offset by
inflation and correspondingly higher interest-rate risk due to globally ballooning Central Bank balance sheets. Federal Open
Market Committee (FOMC) forecasters’ views show that the fed-funds rate has a central tendency of 4%–2% real rate plus
2% inflation only beyond 2015.
According to the well-known Okun rule, GDP has to grow by approximately two percentage points over and above its run-rate
to soak up one percentage point of unemployment. This rule means that for unemployment to fall to its steady-state level of
5%, GDP has to grow by 9% in one year or by 4% for six years (assuming that the run rate of GDP is 3% per year). This is not
happening!
The main reasons behind this very low interest-rate environment are twofold: first, the unemployment rate is significantly
higher than its steady state level (slightly below 8% versus 5%), and second inflation is not significantly higher (maybe even
lower depending on how you measure it) than its policy level of about 2% to 2.5% p.a.
The Federal Reserve follows some version of the frequently-cited Taylor rule, or framework , which suggests that the FedFunds rate equals the long-run real rate (about 2%) plus the steady-state inflation rate (approximately 2% to 2.5%) and a
weighted average of the gross domestic product (GDP) gap and the inflation gap. Though there are many interpretations of
the Taylor rule, most economists would agree that the current environment implies a very low or even negative Fed Funds
rate, and that the environment will remain as such until the unemployment rate is on its way to reaching its full-employment
level.
Currently the Federal Reserve is using two instruments of monetary policy



The Fed-Funds rate (stressing not time forecasts, but data dependent forecasts)
Purchases of Treasuries and Agencies (to taper or not?)
Under normal circumstances such an increase in base (or high-powered) money would have resulted in significant levels of
inflation. Currently, however, because the money multiplier has declined significantly due to the 2007-2009 contraction, M1
and M2 have not grown as fast as high-powered money. And, heretofore inflation has not materialized. Nonetheless, global
economic history suggests that inflation may hit suddenly and violently. Thus, this is the current macroeconomic duality: very
low interest rates projecting into the medium-term future offset by high-levels of inflation risk.
Page 3
Executive Summary
The US Macro Outlook and Efficient Funding Strategies




This duality intuitively suggests that an optimal funding strategy might consist of short term borrowings
(to exploit the low short-term rates) coupled with long-term borrowings (to hedge against rising inflation
and interest rates).
In this presentation, we empirically demonstrate that a barbell funding strategy is indeed on the efficient
frontier, and most efficient frontier strategies consist of the barbell plus the 5-year, particularly under
increased liquidity or funding risk eventualities. Once we delineate the barbell with episodic inclusions of
the 5-year, the Chief Financial Officer (CFO) can choose the optimal fixed versus floating mix based on
his pain tolerance for declines in earnings per share (EPS) given the likely moves in short-term rates.
In addition to pain tolerance considerations in choosing his fixed versus floating strategy, the CFO also
looks at comparable analysis of the industry he is operating at. Various industries will have differing
fixed versus floating characteristics depending on their capital structures and the sensitivity of the
particular industry to interest rates.
Most CFOs that I have had conversations with state that the most important choice in liability
management is the fixed versus floating mix and not the maturity mix. Nonetheless, I posit that the
maturity mix should be predicated on an efficient frontier type analysis combined with a probabilistic and
economic determination of which instrument would be the likely winner over a planning horizon.
Page 4
Executive Summary
The US Macro Outlook and Efficient Funding Strategies

A major caveat for floating-rate funders is that interest rates can jump violently. For example,
in the period from 1990 to the present, we have experienced three major periods where shortterm rates (3M Libor) have moved significantly over a few years




3.19% (2/93) to 6.50% (12/94), or 331 bps in one year ten months.
4.97% (1/99) to 6.81% (9/00), or 184 bps in one year eight months.
1.11% (3/04) to 5.48% (6/06), or 437 bps in two years and three months.
On the good news side, corporate spreads are negatively correlated with quarter-on-quarter
annualized percentage changes in GDP (R2 of 59%). In this respect, the CFO is partially
hedged in that when the economy does well, the risk-free rate will likely go up, but credit
spreads will likely go down; and conversely.
Page 5
Executive Summary
A Sixty-Year History of Interest Rates

When analyzing the history of interest rates, we have to bear in mind that the nominal interest rate
consists of three building blocks.







The real rate of interest (i.e. inflation adjusted, or TIPS)
Inflationary expectations
Credit Spreads
The long term real rate of interest approaches long-term GDP growth, both of which converge to
3% per year.
Because the short-term interest rate approaches 2% in the long-run, we conclude that the TIPS
yield curve has a 100 bps spread (3M-30Y) under normal conditions.
We present the statistical distributions of various interest rate spreads in the graphs that follow.
Conventional wisdom suggests that the yield curve flattens before a recession, and steepens
during a recession.
Page 6
Executive Summary
GDP and the Stock Market





S&P 500 Real Earnings are about 100(mean) – 250(median) bps higher than real GDP growth.
This may suggest that throwing out underperformers may improve portfolio returns significantly.
As expected, S&P 400 Real Earnings are higher than that of the S&P 500. Specifically, S&P 400
Real Earnings are about 7% higher than real GDP growth.
Investors may use various metrics such as the P/E multiple to ascertain whether the stock market
is rich or cheap.
The Capital Asset Pricing Model is the classic academic model used for stock valuation. As such
practitioners universally rely on betas and their decomposition into correlation and relative
volatility.
When discussing share repurchase assignments, cost of capital considerations, and equity
valuation with clients, we spend considerable time on the robustness and components of beta;
and the equity market risk premium.
Page 7
Economic Growth Leads the Unemployment Rate and is
More Volatile – The Okun Rule
20.0
2.0
15.0
1.5
10.0
1.0
5.0
0.5
0.0
0.0
-5.0
-0.5
-10.0
-1.0
-15.0
-1.5
Recession
Real GDP (QoQ, %)

GDP growth = 3.33 – 1.82*(change in unemployment)
t statistics:
(18.22) (15.38)
Adj. R2 = 48.50%

This confirms the study by Abel and Bernanke, 2005
Change in Unemployment (%)
Growth Rate (%)
US Unemployment Rate and Rate of Growth of U.S. GDP, Dec 1949 – Mar 2013
Change in Unemployment (QoQ, %)
Source: Bloomberg.
Page 8
The Fed’s Reaction Function and the Taylor Rule, 1971-2013
22
17
Rates/Spread (%)
22
Following the
bursting of the
TMT bubble,
the Fed kept
rates lower
than the
Taylor rule to
fight dreaded
deflation
12
17
12
7
7
2
2
-3
-3
-8
-8
Recession
Spread: Fed Funds - Taylor Estimate
Fed Funds Rate Target
Taylor Rule Estimate
 The Taylor rule is widely used to explain Fed-fund targets rates
 Real Rate+Core Inflation+½*(Inflation–Target Inflation)+½*Okun Factor*(Normal Unemployment–
Unemployment)
 In the recent past, with unusually high unemployment and low inflation, the rule called for
negative rates
 This is yet another indication that short rates may stay low for some time
Source: Bloomberg, NBER.
Page 9
FOMC Overview of Monetary Policy
FOMC Outlook on Pace of Policy Firming
March 2013
June 2013
5
•••
•••
•••••••••
•
••
•
•
4
•
3
•
2
•
0
•
••••••••••••••••••
••
•
••••••••••••••
••••
••
•
•••••••
•
2013
2014
2015
•
1
•
Target Fed Funds Rate (%)
Target Fed Funds Rate (%)
5
4
•••
3
•
••••••••••••••••••
••••••••••••••
•
•••
••
••••
•••
••
•
2013
2014
2015
2
•
•••
1
0
Long Run
•••
•••
•••••••••
•
••
•
Long Run
FOMC Outlook on Timing of Policy Firming
March 2013
June 2013
14
13
14
12
10
8
4
6
4
1
1
2
Num ber of Participants
14
Num ber of Participants
Since its
December 2012
meeting, FOMC
maintained that
low rates are
appropriate at
least as long as
the
unemployment
rate remains
above 6-1/2%,
inflation
between one
and two years
ahead is
projected to be
no more than a
half percentage
point above
the
Committee's
2% longer-run
goal, and
longer-term
inflation
expectations
continue to be
well anchored.
12
10
8
6
3
4
1
1
2
0
2013
Note: March & June 2013 Minutes
2014
2015
2016
0
2013
2014
2015
2016
Source: Federal Reserve
Page 10
Economic Forecasts
Historical & Forecasted US Real GDP Growth Rate, 1Q07 – 2Q14
Historical & Forecasted 10-Year Treasury Rate, 1Q07 – 2Q14
10.00
8.00
7.00
Med ian
High
Lo w
BOA
BC
C
GS
JPM
6.00
6.00
High
Low
BC
BOA
C
GS
JPM
Nomura
5.00
US 10-Yr. Note (%)
4.00
US Real GDP (QoQ %)
Median
Nomura
2.00
0.00
-2.00
-4.00
4.00
3.00
2.00
-6.00
1.00
-8.00
-10.00
0.00

Bloomberg consensus and the selected economists project that the economy will continue expansion in
2013, albeit with a slow starting 2013

Most forecasters are optimistic because they think that the negative effects of sequestration will wear off,
adding 100–150 bps to GDP; in addition to good news about US energy supplies.
Note: Upper and lower bounds represent Bloomberg’s survey of approximately 80 economists
Source: Wall Street research, Bloomberg.
Page 11
US Money Supply Growth (Assets of the Fed)
Federal Reserve Balance Sheet Size, Dec 2007 – Jul 2013
QE III
Sep 12, 2012 - Current
MBS: + $40BN/Month
QE IV
4,000
QE I
QE II
Agency Debt: +175BN
MBS: + $1.25TN
LT Trea suries: + $300BN
LT Trea suries:
+ $600BN
Balance Sheet Size ($ Billion)
3,500
Nov 3, 2010
Mar 2010
Nov 25, 2008
3,000
Op. Twist
ST Trea s uries: $667BN
Sep 21, 2011 LT Trea suries: +
$667BN
(Ups ized i n June
Jun 2011
2012)
Jan 30, 2013 - Current
LT Treeasuries: +
$45BN/Month
Dec 2012
2,500
2,000
1,500
1,000
500
Mortgage-Backed Securities Held Outright
Term Auction Faciliity
Jun-13
Apr-13
Feb-13
Dec-12
Oct-12
Jun-12
Aug-12
Apr-12
Feb-12
Oct-11
Dec-11
Jun-11
Aug-11
Apr-11
Feb-11
Oct-10
Dec-10
Jun-10
Aug-10
Apr-10
Feb-10
Oct-09
Dec-09
Jun-09
US Treasury Securities Held Outright
Loans (Incl. Term Asset-Backed Securities Loan Facility)
Other Assets
Aug-09
Apr-09
Feb-09
Oct-08
Dec-08
Jun-08
Aug-08
Apr-08
Feb-08
Dec-07
-
Federal Agency Debt Securities Held Outright
Commercial Paper Funding Facility

Following the onset of the financial crisis, the Federal Reserve used a variety of tools at its disposal to stimulate economic
growth and pump liquidity into the financial sector. As a result of the Fed’s open market operations (OMOs), by the end of 2012
the size of the Federal Reserve balance sheet has tripled

As of the end of June 2013, the Fed is continuing to purchase $40 billion of MBS and $45 billion of LT Treasury securities on a
monthly basis, accounting for about 7.5% of the US annual nominal GDP. In comparison, the US budget deficit peaked in 2009 at
around 10% of annual GDP and has since been steadily declining. As of Mar 2013, the US budget deficit was 5.7% of the nominal
GDP, on an annualized basis
Note: Other assets = Repo agreements + assets related to the financial crisis + central bank liquidity swaps + other assets + gold + special drawing rights +
treasury currency
Source: Bloomberg
Page 12
US Money Supply Growth (Liabilities of the Fed)
Federal Reserve Liabilities, Dec 2007 – Jul 2013
QE III
Sep 12, 2012 - Current
MBS: + $40BN/Month
QE IV
Op. Twist
ST Trea s uries: QE II
$667BN
LT Trea suries:
LT Trea suries: +
+ $600BN
Sep 21, 2011
$667BN
(Ups ized i n June
2012)
Jun 2011
Nov 3, 2010
QE I
Agency Debt: +175BN
MBS: + $1.25TN
LT Trea suries: + $300BN
4,000
Balance Sheet Size ($ Billion)
3,500
Mar 2010
Nov 25, 2008
Jan 30, 2013 - Current
LT Treeasuries: +
$45BN/Month
Dec 2012
3,000
2,500
2,000
1,500
1,000
500

Other Factors Absorbing Reserve Funds
Jun-13
Apr-13
Feb-13
Oct-12
Dec-12
Jun-12
Aug-12
Apr-12
Feb-12
Oct-11
Dec-11
Jun-11
Aug-11
Apr-11
Feb-11
Dec-10
Oct-10
Jun-10
Aug-10
Apr-10
Feb-10
Oct-09
Dec-09
Jun-09
Aug-09
Apr-09
Feb-09
Oct-08
Currency In Circulation
Dec-08
Jun-08
Aug-08
Apr-08
Feb-08
Dec-07
-
Reserve Balances with Federal Reserve Banks
The expansion of the Federal Reserve’s balance sheet since the onset of the financial crisis has been
matched on the liabilities side primarily through the expansion in deposits of depository institutions
Source: Bloomberg
Page 13
Interest Rate Environment Following the Financial Crisis
10-Year Nominal Interest Rate, Nov 2007 - Jul 2013
5.0%
QE II: Nov 3, 2010 - Jun 2011 Twist: Sep 21, 2011 - Dec 2012 QE III: Sep 12, 2012 - Current
LT Treasuries: + $600BN
ST Treasuries: - $667BN
MBS: + $40BN/Month
LT Treasuries: + $667BN
QE IV: Jan 30, 2013 - Current
LT Treasuries + $45BN/Month
4.5%
10-Year Real Rate
4.0%
FOMC Meeting
Jun 19, 2013
QE IV Begins
Jan 30, 2013
Op Twist Extension
Jun 20, 2012
3.5%
3.0%
2.5%
2.0%
0.59%
1.5%
0.72%
1.0%
0.03%
-0.10%
0.73%
0.5%
No Policy

QE I
QE II
Op Twist
Jul-13
May-13
Mar-13
Jan-13
Nov-12
Sep-12
Jul-12
May-12
Mar-12
Jan-12
Sep-11
Op Twist + QE III
Nov-11
Jul-11
Mar-11
May-11
Jan-11
Nov-10
Jul-10
Sep-10
May-10
Jan-10
Mar-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
Mar-08
May-08
Jan-08
Nov-07
0.0%
QE III + QE IV
Economists surmise the following:

QE during extreme crisis has been more effective than at other times

QE has diminishing marginal returns

The question is: when are diminishing marginal returns offset by marginal costs?
Source: Bloomberg, Federal Reserve.
Page 14
Interest Rate Environment Following the Financial Crisis
10-Year Real Rate Interest (TIPS), Nov 2007 - Jul 2013
3.5%
QE II: Nov 3, 2010 - Jun 2011 Twist: Sep 21, 2011 - Dec 2012 QE III: Sep 12, 2012 - Current
LT Treasuries: + $600BN
ST Treasuries: - $667BN
MBS: + $40BN/Month
LT Treasuries: + $667BN
QE IV: Jan 30, 2013 - Current
LT Treasuries + $45BN/Month
3.0%
10-Year Real Rate
2.5%
2.0%
FOMC Meeting
Jun 19, 2013
QE IV Begins
Jan 30, 2013
Op Twist Extension
Jun 20, 2012
1.5%
1.0%
0.5%
-1.16%
0.0%
0.28%
-0.5%
-1.0%
-1.5%
-0.63%
1.27%
0.01%
No Policy
QE I
QE II
Jul-13
Mar-13
May-13
Jan-13
Nov-12
Jul-12
Sep-12
May-12
Jan-12
Mar-12
Nov-11
Jul-11
Op Twist + QE III
Sep-11
May-11
Jan-11
Mar-11
Nov-10
Jul-10
Op Twist
Sep-10
May-10
Jan-10
Mar-10
Nov-09
Jul-09
Sep-09
May-09
Jan-09
Mar-09
Nov-08
Jul-08
Sep-08
May-08
Mar-08
Jan-08
Nov-07
-2.0%
QE III + QE IV

Real rates have been steadily declining following the recession. We observe that in the long-run, real rates
loosely match the growth in GDP. 2010 to date, the US GDP growth rate has hovered in the vicinity of 2%, yet
the 10-year TIPS rate has been substantially below that mark

Even with the recent pullback, real rates remain considerably below their long-term average of 2.5%. It
appears that the Fed’s aggressive asset purchase response to the financial crisis manifested itself primarily
through severe compression in the real rates, which would also explain the violent spike in rates following
the QE taper talks
Source: Bloomberg, Federal Reserve.
Page 15
Interest Rate Environment Following the Financial Crisis
10-Year Breakeven Rate (Inflationary Expectations), Nov 2007 - Jul 2013
4.0% QE I: Nov 25, 2008 - Mar 2010 QE II: Nov 3, 2010 - Jun 2011 Twist: Sep 21, 2011 - Dec 2012 QE III: Sep 12, 2012 - Current
Agency Debt: + $175BN
MBS: + $1.25TN
LT Treasuries: + $300BN
10-Year Breakeven Rate
3.5%
3.0%
LT Treasuries: + $600BN
FOMC Meeting
Jun 19, 2013
MBS: + $40BN/Month
QE IV Begins
QE IV: Jan 30, 2013 - Current
Op Twist Extension Jan 30, 2013
LT Treasuries + $45BN/Month
Jun 20, 2012
ST Treasuries: - $667BN
LT Treasuries: + $667BN
2.5%
2.0%
-0.03%
0.23%
1.5%
-0.40%
0.53%
1.0%
0.5%
0.0%
QE I
QE II
Op Twist
Op Twist + QE III
Jul-13
May-13
Mar-13
Jan-13
Nov-12
Sep-12
Jul-12
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Sep-10
Nov-10
Jul-10
Mar-10
May-10
Jan-10
Sep-09
Nov-09
Mar-09
May-09
Jan-09
Sep-08
Nov-08
Jul-08
May-08
Jan-08
Mar-08
Nov-07
No Policy
Jul-09
1.93%
-0.5%
QE III + QE IV

10-year breakeven rates have generally risen through the QE periods and have decreased in the periods
between Fed asset purchases, probably reflective of the expansive monetary policy needed to sustain
additional asset purchases

Since May 1st and the beginning of the tapering talks, the breakeven 10-year rate has declined by 25 bps. 10year expected inflation is currently at 2%, below historical average change in Core CPI (CCPI), but in-line with
Fed’s current target inflation rate
Source: Bloomberg, Federal Reserve.
Page 16
Interest Rate Environment Following the Financial Crisis
10-Year BBB Industrial Credit Spread, Nov 2007 - Jul 2013
500
QE II: Nov 3, 2010 - Jun 2011 Twist: Sep 21, 2011 - Dec 2012 QE III: Sep 12, 2012 - Current
MBS: + $40BN/Month
LT Treasuries: + $600BN
ST Treasuries: - $667BN
QE IV: Jan 30, 2013 - Current
LT Treasuries: + $667BN
+ $45BN/Month
SepTreasuries
12, 2012 - Current
QE II: Nov 3, 2010 - Jun 2011 Twist: Sep 21, 2011 - Dec 2012 QE III:LT
450
500
450
LT Treasuries: + $600BN
Jan 30, 2013
No Policy
QE I
QE II
Op Twist
Op Twist
6
Jul-13
Mar-13
May-13
Jan-13
Nov-12
Sep-12
May-13
Jan-13
Jul-12
6
Mar-13
May-12
Nov-12
Jul-12
Jan-12
Mar-12
Sep-12
May-12
Mar-12
Nov-11
Jul-11
Op Twist + QE III
Sep-11
Jan-12
Sep-11
Op Twist + QE III
Nov-11
Jul-11
May-11
Jan-11
Jan-11
Mar-11
Nov-10
Nov-10
Jul-10
Jul-10
Sep-10
Sep-10
Jan-10
QE II
Mar-10
Mar-10
Sep-09
Jul-09
Mar-09
QE I
May-09
May-09
Jan-09
Mar-09
Nov-08
Jan-09
Jul-08
No Policy
Sep-08
Sep-08
Mar-08
May-08
Nov-08
Jul-08
Jan-08
Nov-07
0
-10
-27
-29
-277
-10
-27
-29
-277
May-11
Mar-11
150
May-08
Mar-08
Jan-08
Nov-07
Jun
2012
QE20,
IV Begins
200
50
0
Op
250
100
50
QE IV Begins
30, 2013
Jan
FOMC Meeting
Jun 19, 2013
Twist Extension
Op Twist Extension
Jun 20, 2012
Nov-09
Jan-10
150
MBS: + $40BN/Month
QE IV: Jan 30, 2013 - Current
LT Treasuries + $45BN/Month
300
Jul-09
200
350
Nov-09
Sep-09
250
100

ST Treasuries: - $667BN
LT Treasuries: + $667BN
400
May-10
300
May-10
350
10-Year Credit Spread
10-Year Credit Spread
400
FOMC Meeting
Jun 19, 2013
Series8
QE III + QE IV
10-year credit spreads contracted sharply during QE I, which coincided with the end of the recession and
have remained relatively stable subsequent to that. Still, we can observe credit spreads tightening during QE
periods and widening in-between QE periods, possibly reflective of the downward pressure on rates caused
by the Fed asset purchases
Source: Bloomberg, Federal Reserve.
Page 17
Behavior of Credit Spreads
200
700
High Grade Option Adjusted Spread (bps)
162.5
R² = 0.5578
Mar-09
Median Change in HG Spread (bps)
Dec-08
600
500
Sep-08
400
Jun-09
Jun-08
300
Sep-09
Sep-11
Dec-11
Dec-02
Jun-12
Sep-00
200
Mar-12
Dec-12
Sep-12
Mar-11 Mar-13 Jun-11
100
150
100
50
0
-14.5
-50
-56
Jun-07
Jun-97
0
-10
-8
-6
-4
-2
0
2
4
6
-51
-100
8
10
-1.61% to -0.43%
-0.43% to -0.02%
-0.02% to 0.35%
Change in 10Y UST
0.35% to 0.87%
US GDP (QoQ,%)


As expected, credit spreads are negatively correlated with GDP
Moreover, spread movements seem to significantly offset movements
in treasuries
Page 18
1.
US Macroeconomic Outlook
2.
Efficient-Frontier Funding Strategies
3.
A Sixty-Year History of Interest Rates
4.
History of Economic Growth: GDP and the Stock
Market
Page 19
Behavior of US Interest Rates, Jun 1954 - Present
Yield, Spread (%)
15%
10%
5%
Dec-94
Dec-96
Dec-98
Dec-00
Dec-02
Dec-04
Dec-06
Dec-08
Dec-10
Dec-12
Dec-96
Dec-98
Dec-00
Dec-02
Dec-04
Dec-06
Dec-08
Dec-10
Dec-12
Dec-92
Dec-90
Dec-88
Dec-86
Dec-84
Dec-82
3M UST
Dec-94
Recession
Dec-80
Dec-78
Dec-76
Dec-74
Dec-72
Dec-70
Dec-68
Dec-66
Dec-64
Dec-62
Dec-60
Dec-58
Dec-56
0%
Dec-54
Government Rates
20%
20Y UST
15%
10%
5%
Recession
AAA Long Term Rate
Dec-92
Dec-90
Dec-88
Dec-86
Dec-84
Dec-82
Dec-80
Dec-78
Dec-76
Dec-74
Dec-72
Dec-70
Dec-68
Dec-66
Dec-64
Dec-62
Dec-60
Dec-58
Dec-56
0%
Dec-54
Yield, Spread (%)
20%
Corporate Rates (Moody’s)
Until the early
1980s, US interest
rates trended up,
primarily driven
by rising inflation.
Since then, the
trend has
reversed itself,
primarily by
falling inflation,
but also by
declining real
interest rates,
particularly after
the onset of the
2007 great
contraction.
Because issuing
long-term is
beneficial in a
rising rate
environment, the
liability
management
decision is
effectively a
forecasting
exercise.
BAA Long Term Rate
Source: Federal Reserve.
Page 20
The Efficient Frontier: A Corporate Treasurer’s Perspective
(Cont’d)
Liability Portfolio Efficient Frontier in a Rising Interest Rate Environment, Apr 1953 – Apr 1973,
(Using Treasury Rates)
4.30%
4.10%
100% 3-Year
20% 3M, 20% 3Y, 20% 5Y,
20% 10Y, 20% 20Y
3.90%
Cost of Funding
During periods
of rising
interest rates,
as observed in
the US from
1953 to 1973,
issuing longterm debt
proves to be an
outright winner
over shorterterm options.
This strategy
provides
issuers with
the lowest
interest rate
volatility and
the lowest cost
of funding.
Stated
differently, the
efficient
frontier
consists of one
point.
100% 5-Year
3.70%
100% 3-Month
100% 10-Year
3.50%
3.30%
3.10%
90% 3M, 10% 20Y
80% 3M, 20% 20Y
70% 3M, 30% 20Y
60% 3M, 40% 20Y
50% 3M, 50% 20Y
40% 3M, 60% 20Y
30% 3M, 70% 20Y
25% 3M, 25% 5Y,
20% 3M, 80% 20Y
25% 10Y, 25% 20Y
10% 3M, 90% 20Y
100% 20-Year
2.90%
0.00%
0.50%
1.00%
1.50%
2.00%
Standard Deviation
Barbells (3M and 20Y)
Efficient Frontier
Source: Federal Reserve, calculations by Ramirez & Co.
Page 21
The Efficient Frontier: A Corporate Treasurer’s Perspective
(Cont’d)
Liability Portfolio Efficient Frontier in a Falling Interest Rate Environment, Jan 1993 – Jul 2013,
(Using Treasury Rates)
7.50%
100% 20-Year
10% 3Y, 90% 20Y
6.50%
20% 3Y, 80% 20Y
30% 3Y, 70% 20Y
40% 3Y, 60% 20Y
Cost of Funding
During periods
of falling
interest rates
as observed in
the US from
1991 to 2013,
the issuer
faces a tradeoff
between lowest
funding cost
volatility
(achieved by
issuing longterm debt) and
lowest funding
cost (achieved
by issuing
short-term
debt).
5.50%
4.50%
3.50%
50% 3Y, 50% 20Y
100% 10-Year
25% 3M, 25% 5Y, 25% 10Y,
25% 30Y
20% 3M, 20% 3Y, 20% 5Y,
20% 10Y, 20% 30Y
100% 5-Year
100% 3-Year
20% 3M, 80% 3Y
40% 3M, 60% 3Y
60% 3M, 40% 3Y
80% 3M, 20% 3Y
100% 3-Month
2.50%
1.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
Standard Deviation
Barbells (3M and 20Y)
Efficient Frontier
Source: Federal Reserve, calculations by Ramirez & Co.
Page 22
The Efficient Frontier: A Corporate Treasurer’s Perspective
(Cont’d)
Liability Portfolio Efficient Frontier in a Mixed Interest Rate Environment, Apr 1953 – Jul 2013,
(Using Treasury Rates)
5.90%
20% 3M, 20% 3Y,
25% 3M, 25% 5Y,
20% 5Y, 20% 10Y, 20% 20Y
25% 10Y, 25% 20Y
5.80%
100% 10-Year
100% 20-Year
100% 3-Year
5.70%
5.60%
20% 3M, 80% 20Y
Cost of Funding
During periods
of both rising
and falling
interest rates
as observed in
the US from
1953 to 2013,
the issuer
faces a
tradeoff similar
to a falling
interest rate
environment.
As such, the
efficient
frontier
consists of a
barbell
strategy of 3M
and 20Y
instruments
(except for the
100% 20-Year
point).
5.50%
30% 3M, 70% 20Y
5.40%
40% 3M, 60% 20Y
100% 5-Year
50% 3M, 50% 20Y
5.30%
60% 3M, 40% 20Y
5.20%
70% 3M, 30% 20Y
5.10%
80% 3M, 20% 20Y
90% 3M, 10% 20Y
5.00%
100% 3-Month
4.90%
4.80%
1.25%
1.45%
1.65%
1.85%
2.05%
2.25%
2.45%
2.65%
2.85%
3.05%
3.25%
Standard Deviation
Efficient Frontier
Source: Federal Reserve, calculations by Ramirez & Co.
Page 23
The Efficient Frontier: A Corporate Treasurer’s Perspective
(Cont’d)
Liability Portfolio Efficient Frontier, May 1994 – Jul 2013,
(Using Shock-Adjusted SWAP Rates)
8.50%
8.00%
100% 20-Year
7.50%
10% 3M, 10% 5Y, 80% 20Y
7.00%
20% 3M, 10% 5Y, 70% 20Y
Cost of Funding
Using shockadjusted SWAP
rates (500 bps in
September 2008
– September
2009), the
barbell strategy
moves away
from the
efficient frontier.
The evenly
distributed 3M,
5Y, and 20Y
portfolio is
exactly on the
efficient frontier.
This observation
suggests that
the 3M, 5Y, and
20Y instruments
may be the
principle
instruments in
determining the
efficient frontier.
6.50%
20% 3M, 20% 5Y, 60% 20Y
100% 10-Year
6.00%
20% 3M, 20% 3Y, 20% 5Y,
20% 10Y, 20% 20Y
100% 5-Year
5.50%
25% 3M, 25% 5Y,
25% 10Y, 25% 20Y
5.00%
100% 3-Year
50% 3M, 40% 5Y, 10% 20Y
4.50%
60% 3M, 40% 5Y
80% 3M, 20% 5Y
90% 3M, 10% 5Y
4.00%
3.50%
0.00%
0.50%
1.00%
1.50%
2.00%
100% 3-Month
2.50%
Standard Deviation
Barbells (3M and 20Y)
Efficient Frontier
Source: Bloomberg, calculations by Ramirez & Co.
Page 24
EPS Sensitivity Under Varying Funding Scenarios
2013 EPS Estimate vs. % Floating Rate Debt Mix Under Varying 3-Month LIBOR Assumptions
Debt Portfolio
(% Floating)
Floating Debt Fixed Rate Debt
($ Mil)
($ Mil)
Consensus EPS FY13
($ per Share)
3M LIBOR +1 Standard Deviation = 2.86%
FY13E EPS
($ per Share)
% Change
3M LIBOR +2 Standard Deviations = 5.45%
FY13E EPS
($ per Share)
% Change
10.30
541.6
4,718.9
2.44
2.40
-1.61
2.36
-3.22
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
100.00
0.0
526.1
1,052.1
1,578.2
2,104.2
2,630.3
3,156.3
3,682.4
4,208.4
4,734.5
5,260.5
5,260.5
4,734.5
4,208.4
3,682.4
3,156.3
2,630.3
2,104.2
1,578.2
1,052.1
526.1
0.0
2.37
2.44
2.51
2.57
2.64
2.71
2.78
2.85
2.92
2.99
3.06
2.37
2.40
2.43
2.46
2.49
2.52
2.55
2.58
2.61
2.64
2.67
0.00
-1.57
-3.05
-4.45
-5.78
-7.04
-8.24
-9.38
-10.47
-11.51
-12.50
2.37
2.36
2.35
2.35
2.34
2.33
2.32
2.31
2.31
2.30
2.29
0.00
-3.13
-6.10
-8.90
-11.56
-14.08
-16.48
-18.77
-20.94
-23.02
-25.00
 Floating rate debt generally provides firms with lower cost of funding during
upward-sloping yield curve environments, however, issuing floating-rate debt leaves
firms with added cash flow volatility
 With 3-Month LIBOR near its all-time lows, assuming a one standard deviation move
up in LIBOR still makes floating-rate debt appear relatively more attractive
Note: 3-Month LIBOR standard deviation calculated based on 25-years of historical data.
Variable borrowing spread of 20 bps used; weighted-average borrowing cost on WEC variable-rate LT debt as of 12/31/12.
2013 Consensus EPS and weighted average long-term cost of funding figures as per Bloomberg.
Source: Company Filings, Bloomberg.
Page 25
Issuing 30Y vs. 10Y Plus 20Y
Currently, 10Y,
20Y and 30Y
Single A rated
Utility yields
are 3.59%,
4.64% and
4.54%,
respectively.
If the 20Y rate
increases to
5.67% and
beyond in 10
years, a
current 30Y
funding would
be more cost
efficient.
This
represents an
103 bps
increase from
today’s 20Y
level.
30Y Financing vs. 10Y and Subsequent 20Y: Break-Even Rates
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
Cash Flow
$3.59
3.59
3.59
3.59
3.59
3.59
3.59
3.59
3.59
3.59
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
5.43
105.43
Discount Rate
(30Y Coupon Yield)
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
4.54%
DCF
$3.43
3.29
3.14
3.01
2.88
2.75
2.63
2.52
2.41
2.30
3.34
3.19
3.05
2.92
2.79
2.67
2.56
2.45
2.34
2.24
2.14
2.05
1.96
1.87
1.79
1.71
1.64
1.57
1.50
27.86
$100.00
Note: Based on indicative data for the Utilities index, the Company’s yields may be different.
Cash Flow
$3.59
3.59
3.59
3.59
3.59
3.59
3.59
3.59
3.59
3.59
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
5.67
105.67
Discount Rates
(Bootstrapped)
0.38%
0.71%
1.13%
1.61%
2.06%
2.46%
2.86%
3.27%
3.54%
3.84%
4.02%
4.20%
4.38%
4.56%
4.74%
4.84%
4.94%
5.03%
5.13%
5.23%
5.19%
5.15%
5.11%
5.07%
5.02%
4.98%
4.94%
4.90%
4.86%
4.82%
DCF
$3.58
3.54
3.47
3.37
3.24
3.10
2.95
2.78
2.62
2.46
3.68
3.46
3.25
3.04
2.83
2.66
2.50
2.34
2.19
2.05
1.96
1.88
1.80
1.73
1.67
1.60
1.54
1.49
1.43
25.76
$100.00
Source: Bloomberg, Ramirez & Co. estimates.
Page 26
Interest Rates Scenarios
Neutral, 10Y Horizon
Reverting to the Mean, 10Y Horizon
24%
24%
Probability of Rate Increase by Over 103.0 bps: 30.3%
22%
20%
20%
18%
18%
16%
16%
Simulated Path
Trend 20 bps pa
-2 StDev
Simulated Path
Trend 0 bps pa
+2 StDev
-2 StDev

From 1984 to the present, corporate yields have trended down at an approximate rate of 20 bps
per year. Mean-reversion of rates would suggest that the likelihood of an increase of over 103
bps in long-term rates is approximately 66%

With zero trend, the likelihood of an over increase over 103 bps is around 30%
Note: Based on volatility of 3.09% per month (10.71% annualized), per ML BBB/A 15+ Industrial Index.
Jul-23
Jan-23
Jul-22
Jul-21
Jan-22
Jan-21
Jul-20
Jul-19
Jan-20
Jul-18
Jan-19
Jul-17
Jan-18
Jul-16
Jan-17
Jan-16
Jul-15
Jul-14
Jul-23
Jul-22
Jan-23
Jan-22
Jul-21
Jul-20
+2 StDev
Jan-21
Jul-19
Jan-20
Jul-18
Jan-19
Jul-17
2%
Jan-18
2%
Jan-17
4%
Jul-16
4%
Jul-15
6%
Jan-16
6%
Jan-15
8%
Jul-14
8%
Jul-13
10%
Jan-14
10%
Jan-15
12%
Jan-14
12%
14%
Jul-13
14%
Jan-13
Yield (%)
22%
Jan-13
Yield (%)
Probability of Rate Increase by Over 103.0 bps: 66.1%
Source: Ramirez & Co. estimates.
Page 27
Interest Rates Scenarios (Cont’d)
High Inflation, 10Y Horizon
24%
Probability of Rate Increase by Over 103.0 bps: 92.2%
22%

20%
18%
14%
 Inflated Fed balance sheet
12%
 High commodity prices (e.g. gold and oil)
10%
8%
6%
Simulated Path
Trend 50 bps pa
Jul-23
Jul-22
Jan-23
Jan-22
Jul-21
Jul-20
+2 StDev
Jan-21
Jul-19
Jul-18
Jan-19
Jul-17
Jan-18
Jan-17
Jul-16
Jul-15
Jan-16
Jan-15
Jul-14
Jul-13
Jan-14
2%
Jan-20
4%
Jan-13
Yield (%)
16%
While inflation does not seem to be an immediate
threat, a number of factors suggest that it may
be a future threat
-2 StDev
Note: Based on volatility of 3.09% per month (10.71% annualized), per ML BBB/A 15+ Industrial Index.
Source: Ramirez & Co. estimates.
Page 28
1.
US Macroeconomic Outlook
2.
Efficient-Frontier Funding Strategies
3.
A Sixty-Year History of Interest Rates
4.
History of Economic Growth: GDP and the Stock
Market
Page 29
US Recession
UST 3M
LIBOR 3M
Feb-12
Sep-10
Apr-09
Nov-07
Jun-06
Jan-05
Aug-03
Mar-02
Oct-00
May-99
Dec-97
Jul-96
Feb-95
Sep-93
Apr-92
Nov-90
Jun-89
Jan-88
Aug-86
Mar-85
Oct-83
May-82
Dec-80
Jul-79
Feb-78
Sep-76
Apr-75
Nov-73
Jun-72
Jan-71
Aug-69
Mar-68
Oct-66
May-65
Dec-63
Jul-62
Feb-61
Sep-59
Apr-58
Nov-56
Jun-55
Jan-54
Short-Term Interest Rates
25%
20%
15%
10%
5%
0%
Central Bank Target Rate
 Short-term rates decline during recessions
Page 30
US Treasury Rates
3M T-Bill Yield, Jan 1954 – Jun 2013
3Y T-Note Yield, Apr 1953 – Jun 2013
14.00%
9.00%
June 2013: 0.04%
Mean: 4.77%
12.00%
8.00%
Median: 4.69%
Standard Deviation: 3.04%
Kurtosis: 1.13%
Frequency
Skewness: 0.81%
8.00%
6.00%
Mean: 5.60%
Median: 5.37%
7.00%
Standard Deviation: 3.05%
6.00%
Skewness: 0.74%
Kurtosis: 0.70%
5.00%
4.00%
3.00%
4.00%
2.00%
2.00%
1.00%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
16.0%
17.0%
14.0%
5Y T-Note Yield, Apr 1953 – Jun 2013
Note: The data start on Jan 1954 for the 3M UST
12.00%
June 2013: 1.19%
10.00%
Frequency
8.00%
Mean: 5.84%
Median: 5.57%
Standard Deviation: 2.94%
Kurtosis: 0.65%
Skewness: 0.80%
6.00%
4.00%
2.00%
0.00%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
16.0%
13.0%
12.0%
11.0%
9.0%
10.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
0.00%
-3.0%
0.00%
-4.0%
Frequency
10.00%
June 2013: 0.57%
Source: Ramirez & Co. calculations, Federal Reserve, Bloomberg.
Page 31
US Treasury Rates (Cont.)
10Y T-Note Yield, Apr 1953 – Jun 2013
20Y T-Bond Yield, Apr 1953 – Jun 2013
12.00%
14.00%
June 2013: 2.29%
June 2013: 3.07%
Mean: 6.13%
10.00%
Standard Deviation: 2.77%
Median: 5.99%
Standard Deviation: 2.66%
10.00%
Kurtosis: 0.58%
Frequency
Skewness: 0.90%
6.00%
4.00%
Kurtosis: 0.54%
Skewness: 0.91%
8.00%
6.00%
16.0%
15.0%
14.0%
13.0%
12.0%
11.0%
9.0%
10.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
15.5%
14.5%
13.5%
12.5%
11.5%
10.5%
9.5%
8.5%
7.5%
6.5%
5.5%
4.5%
3.5%
2.5%
1.5%
0.5%
0.00%
-0.5%
0.00%
-1.5%
2.00%
-2.5%
2.00%
0.0%
4.00%
-1.0%
Frequency
8.00%
Mean: 6.35%
12.00%
Median: 5.72%
Note: Data for the 20Y UST are not available for Jan 87 – Sep 93. We compute the missing data by
linearly interpolating the 10Y and the 30Y. No data available for June 2013 as of July 1, 2013.
30Y T-Bond Yield, Feb 1977 – Jun 2013
14.00%
12.00%
Mean: 7.20%
June 2013: 3.40%
Median: 6.88%
Standard Deviation: 2.76%
Kurtosis: -0.19%
Skewness: 0.66%
8.00%
6.00%
4.00%
2.00%
Note: Data for the 30Y
UST are not available for
Mar 02 – Jan 06. For this
period Bloomberg
substitutes CUSIP
912810FP, issued
2/15/01 with maturity
date 2/15/31. Moreover,
data for the 30Y are not
available for Apr 53 –
Mar 77.
16.0%
15.0%
14.0%
13.0%
12.0%
11.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
0.00%
-1.0%
Frequency
10.00%
Source: Ramirez & Co. calculations, Federal Reserve, Bloomberg.
Page 32
US Treasury Spreads
3Y – 3M, Jan 1954 – Jun 2013
10Y – 3Y, Apr 1953 – Jun 2013
8.00%
9.00%
Median: 0.87%
June 2013: 1.72%
Mean: 0.52%
Median: 0.38%
Standard Deviation: 0.73%
8.00%
Kurtosis: 1.14%
7.00%
5.00%
Kurtosis: -0.02%
Skewness: 0.00%
6.00%
Skewness: 0.68%
Frequency
6.00%
4.00%
3.00%
Standard Deviation: 0.68%
5.00%
4.00%
3.00%
2.00%
2.00%
-1.50%
-1.30%
-1.10%
-0.90%
-0.70%
-0.50%
-0.30%
-0.10%
0.10%
0.30%
0.50%
0.70%
0.90%
1.10%
1.30%
1.50%
1.70%
1.90%
2.10%
2.30%
2.50%
2.70%
3.30%
3.00%
2.70%
2.40%
2.10%
1.80%
1.50%
1.20%
10Y – 5Y, Apr 1953 – Jun 2013
9.00%
June 2013: 1.10%
8.00%
Mean: 0.29%
Median: 0.20%
7.00%
Standard Deviation: 0.41%
6.00%
Kurtosis: 0.18%
5.00%
Skewness: 0.74%
4.00%
3.00%
2.00%
1.00%
1.60%
1.45%
1.30%
1.15%
1.00%
0.85%
0.70%
0.55%
0.40%
0.25%
0.10%
-0.05%
-0.20%
-0.35%
-0.50%
-0.65%
-0.80%
0.00%
-0.95%
Frequency
0.90%
0.60%
0.30%
0.00%
-0.30%
0.00%
-0.60%
1.00%
0.00%
-0.90%
1.00%
-1.20%
Frequency
7.00%
10.00%
Mean: 0.87%
June 2013: 0.53%
Source: Ramirez & Co. calculations, Federal Reserve, Bloomberg.
Page 33
US Treasury Spreads (Cont.)
20Y – 10Y, Apr 1953 – Jun 2013
30Y – 10Y, Feb 1977 – Jun 2013
10.00%
Median: 0.17%
8.00%
Kurtosis: -0.27%
6.00%
Skewness: 0.39%
5.00%
1.60%
1.45%
1.30%
1.15%
1.00%
0.85%
0.70%
-0.80%
1.60%
1.45%
1.30%
1.15%
1.00%
0.85%
0.70%
0.55%
10.00%
9.00%
8.00%
Mean: -0.02%
June 2013: 0.33%
Median: -0.01%
Standard Deviation: 0.34%
7.00%
Kurtosis: 1.90%
6.00%
Skewness: -0.23%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
-1.10%
-1.00%
-0.90%
-0.80%
-0.70%
-0.60%
-0.50%
-0.40%
-0.30%
-0.20%
-0.10%
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
0.70%
0.80%
0.90%
1.00%
1.10%
0.25%
0.40%
30Y – 20Y, Feb 1977 – Jun 2013
Frequency
0.10%
-0.05%
-0.20%
-0.35%
-0.50%
0.00%
-0.65%
1.00%
0.00%
-0.80%
1.00%
-0.95%
2.00%
-1.10%
3.00%
2.00%
0.55%
4.00%
3.00%
0.40%
4.00%
Standard Deviation: 0.42%
7.00%
0.25%
5.00%
Median: 0.26%
0.10%
Skewness: -0.01%
Mean: 0.33%
-0.05%
6.00%
Frequency
Kurtosis: 1.26%
June 2013: 1.11%
-0.20%
Standard Deviation: 0.41%
7.00%
Frequency
9.00%
-0.35%
8.00%
Mean: 0.22%
-0.50%
June 2013: 0.78%
9.00%
-0.65%
10.00%
Source: Ramirez & Co. calculations, Federal Reserve, Bloomberg.
Page 34
US Recession
10Y-3M
10Y-3Y
20Y-10Y
Apr-13
Apr-11
Apr-09
Apr-07
Apr-05
Apr-03
Apr-01
Apr-99
Apr-97
Apr-95
Apr-93
Apr-91
Apr-89
Apr-87
Apr-85
Apr-83
Apr-81
Apr-79
Apr-77
Apr-75
Apr-73
Apr-71
Apr-69
Apr-67
Apr-65
Apr-63
Apr-61
Apr-59
Apr-57
Apr-55
Apr-53
US Treasury Spreads
5
4
3
2
1
0
-1
-2
-3
30Y-10Y
 Conventional wisdom suggests that the yield curve flattens before a recession, and steepens
during one
Page 35
LIBOR Rates and Spreads
LIBOR 3M, Dec 1984 – Jun 2013
LIBOR – UST 3M Spread, Dec 1984 – Jun 2013
14.00%
20.00%
June 2013: 0.27%
Mean: 4.50%
12.00%
Mean: 0.54%
Median: 0.40%
Standard Deviation: 0.41%
Kurtosis: -0.19%
14.00%
Kurtosis: 5.41%
Skewness: 0.66%
12.00%
Skewness: 1.89%
Frequency
8.00%
June 2013: 0.23%
16.00%
Standard Deviation: 2.76%
10.00%
6.00%
10.00%
8.00%
6.00%
4.00%
4.00%
2.00%
2.00%
1.9%
1.7%
1.5%
1.3%
1.1%
0.9%
0.7%
0.5%
0.3%
0.1%
-0.1%
-0.7%
-0.3%
0.00%
14.0%
13.0%
12.0%
11.0%
9.0%
10.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
0.00%
-0.5%
Frequency
18.00%
Median: 6.88%
3
2.5
2
1.5
1
0.5
0
Note: US Recession periods in gray
Jun-13
Dec-11
Jun-10
Dec-08
Jun-07
Dec-05
Jun-04
Dec-02
Jun-01
Dec-99
Jun-98
Dec-96
Jun-95
Dec-93
Jun-92
Dec-90
Jun-89
Dec-87
Jun-86
-0.5
Dec-84
LIBOR – UST 3M Spread
3.5
Source: Ramirez & Co. calculations, Federal Reserve, Bloomberg.
Page 36
Velocity of Interest Rates
3M Libor and Fed Funds Target Rate vs. 10Y Swap
peak - trough 331 bps in 1 yr
and 10 mos, 180.5 bps/yr
peak - trough 184.3 bps in 1 yr
and 8 mos, 110.4 bps/yr
peak - trough 437 bps in 2 yrs and
3 mos, 194.2 bps/yr
10.0
9.0
Interest Rates (%)
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Recession
Fed
3M Libor
10Y Swap

Short-term rates may increase rapidly as the economy recovers

Following the Fed’s tightening cycle in 2004, short-term rates increased approximately 440 bps in 27
months
Note: Peak to trough LIBOR
Source: Bloomberg.
Page 37
Moody’s Corporate Bond Yields
Moody’s Aaa (30Y), Apr 1953 – Jun 2013
Moody’s Baa (30Y), Apr 1953 – Jun 2013
14.00%
12.00%
June 2013: 4.27%
12.00%
Mean: 7.98%
10.00%
Median: 6.97%
Median: 7.89%
Standard Deviation: 2.96%
Standard Deviation: 2.68%
10.00%
8.00%
Kurtosis: 0.30%
Frequency
Skewness: 0.75%
8.00%
6.00%
Skewness: 0.84%
6.00%
4.00%
4.00%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
16.0%
17.0%
18.0%
16.0%
15.0%
14.0%
13.0%
12.0%
11.0%
9.0%
10.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
0.00%
1.0%
0.00%
0.0%
2.00%
-1.0%
2.00%
Moody’s Aaa Spread vs UST 30Y, Feb 1977 – Jun 2013
Kurtosis: 0.55%
Moody’s Baa Spread vs UST 30Y, Feb 1977 – Jun 2013
25.00%
12.00%
June 2013: 1.33%
June 2013: 0.87%
Mean: 0.80%
20.00%
Median: 1.73%
Standard Deviation: 0.70%
Median: 0.72%
Standard Deviation: 0.37%
8.00%
Frequency
Kurtosis: 1.73%
15.00%
Skewness: 1.13%
10.00%
Kurtosis: 5.09%
Skewness: 1.81%
6.00%
4.00%
5.00%
2.00%
4.50%
4.20%
3.90%
3.60%
3.30%
2.70%
2.40%
2.10%
1.80%
1.50%
1.20%
0.90%
0.60%
0.30%
0.00%
-0.30%
2.20%
2.00%
1.80%
1.60%
1.40%
1.20%
1.00%
0.80%
0.60%
0.40%
0.20%
0.00%
0.00%
-0.20%
0.00%
-0.40%
Frequency
Mean: 1.90%
10.00%
3.00%
Frequency
June 2013: 5.19%
Mean: 7.00%
Note: Credit ratings are for bonds with maturities as close to 30 yrs as possible and no sooner than 20 yrs.
Page 38
Inflation Indicators
US HCPI Inflation, Apr 1953 – May 2013
US CCPI Inflation, Feb 1957 – May 2013
30.00%
20.00%
18.00%
June 2013: 6.17%
Median: 3.66%
25.00%
14.00%
Standard Deviation: 3.95%
Kurtosis: 3.74%
20.00%
12.00%
Skewness: 0.61%
10.00%
8.00%
Mean: 3.84%
Median: 3.66%
Standard Deviation: 3.23%
Frequency
16.00%
Kurtosis: 3.16%
Skewness: 1.44%
15.00%
10.00%
6.00%
4.00%
5.00%
2.00%
17.0%
15.0%
13.0%
11.0%
9.0%
7.0%
5.0%
3.0%
1.0%
-1.0%
-3.0%
-5.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
0.00%
0.00%
-7.0%
Frequency
June 2013: 2.43%
Mean: 3.72%
Note: CCPI Inflation is defined as HCPI excluding food and energy.
Page 39
Treasury Inflation Protected Securities (TIPS)
TIPS 5Y, Jul 1997 – Jun 2013
TIPS 10Y, Jan 1997 – Jun 2013
14.00%
Mean: 2.16%
12.00%
Standard Deviation: 1.65%
10.00%
Skewness: -0.39%
6.5%
6.0%
5.5%
5.0%
4.5%
0.00%
3.5%
0.00%
3.0%
2.00%
2.5%
2.00%
2.0%
4.00%
-2.0%
4.00%
1.5%
6.00%
1.0%
6.00%
8.00%
0.5%
8.00%
Kurtosis: -0.53%
0.0%
Frequency
Skewness: -0.22%
Standard Deviation: 1.35%
-0.5%
Kurtosis: -0.95%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
6.0%
6.5%
TIPS 30Y (Calculated), Jan 1999 – Jun 2013
20.00%
18.00%
Frequency
Mean: 2.33%
June 2013: 1.20%
Median: 2.17%
16.00%
Standard Deviation: 0.98%
14.00%
Kurtosis: -0.42%
12.00%
Skewness: 0.12%
10.00%
8.00%
6.00%
4.00%
2.00%
5.6%
5.2%
4.8%
4.4%
3.6%
3.2%
2.8%
2.4%
2.0%
1.6%
1.2%
0.8%
0.4%
0.0%
0.00%
-0.4%
Frequency
10.00%
June 2013: 0.46%
Median: 2.10%
-1.0%
Median: 1.41%
4.0%
12.00%
June 2013: -0.42%
-1.5%
Mean: 1.60%
4.0%
14.00%
Note: TIPS 30Y calculated as the difference between UST 30Y and the 30Y breakeven index as reported by Bloomberg.
Page 40
Computed UST Real Rates
HCPI Adjusted 3M Real Rate, Jan 1954 – Jun 2013
CCPI Adjusted 3M Real Rate, Feb 1957 – Jun 2013
9.00%
Mean: 1.02%
7.00%
Standard Deviation: 3.48%
6.00%
Kurtosis: 2.61%
Skewness: -0.05%
5.00%
4.00%
3.00%
Mean: 1.09%
June 2013: -2.38%
Median: 1.29%
10.00%
Median: 1.14%
Standard Deviation: 2.63%
Kurtosis: 0.92%
8.00%
Frequency
Frequency
8.00%
12.00%
June 2013: -6.13%
Skewness: 0.02%
6.00%
4.00%
2.00%
2.00%
1.00%
0.00%
9.00%
9.0%
10.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
10.00%
June 2013: -5.60%
Mean: 1.85%
9.00%
Median: 2.10%
Standard Deviation: 3.68%
6.00%
Kurtosis: 2.70%
Skewness: -0.12%
5.00%
4.00%
3.00%
8.00%
Frequency
7.00%
June 2013: -1.86%
Mean: 1.94%
Median: 2.07%
Standard Deviation: 2.79%
7.00%
Kurtosis: 1.35%
6.00%
Skewness: 0.08%
5.00%
4.00%
2.00%
1.00%
1.00%
0.00%
0.00%
-7.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
3.00%
2.00%
-8.5%
-7.5%
-6.5%
-5.5%
-4.5%
-3.5%
-2.5%
-1.5%
-0.5%
0.5%
1.5%
2.5%
3.5%
4.5%
5.5%
6.5%
7.5%
8.5%
9.5%
10.5%
11.5%
12.5%
13.5%
Frequency
-5.0%
CCPI Adjusted 3Y Real Rate, Feb 1957 – Jun 2013
HCPI Adjusted 3Y Real Rate, Apr 1953 – Jun 2013
8.00%
-6.0%
-7.0%
-10.0%
-9.0%
-8.0%
-7.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
0.00%
Page 41
Computed UST Real Rates (cont.)
HCPI Adjusted 5Y Real Rate, Apr 1953 – Jun 2013
CCPI Adjusted 5Y Real Rate, Feb 1957 – Jun 2013
9.00%
12.00%
June 2013: -4.97%
Mean: 2.12%
7.00%
Median: 2.27%
10.00%
Standard Deviation: 3.64%
Standard Deviation: 2.74%
Kurtosis: 2.85%
6.00%
Frequency
Mean: 2.22%
June 2013: -1.23%
Median: 2.38%
Kurtosis: 1.73%
8.00%
Skewness: -0.04%
Frequency
8.00%
5.00%
4.00%
3.00%
Skewness: 0.03%
6.00%
4.00%
2.00%
2.00%
1.00%
CCPI Adjusted 10Y Real Rate, Feb 1957 – Jun 2013
10.00%
14.00%
Mean: 2.41%
June 2013: -3.88%
Median: 2.60%
12.00%
8.00%
Standard Deviation: 3.63%
7.00%
Kurtosis: 3.32%
Mean: 2.51%
June 2013: -0.14%
Median: 2.66%
Standard Deviation: 2.72%
10.00%
Frequency
Skewness: -0.05%
6.00%
5.00%
4.00%
3.00%
11.5%
9.5%
10.5%
8.5%
7.5%
6.5%
5.5%
4.5%
3.5%
2.5%
1.5%
0.5%
-0.5%
-1.5%
-2.5%
-3.5%
-4.5%
-5.5%
-6.5%
14.5%
13.0%
11.5%
8.5%
10.0%
7.0%
5.5%
4.0%
2.5%
1.0%
-0.5%
-2.0%
-3.5%
-5.0%
-6.5%
0.00%
HCPI Adjusted 10Y Real Rate, Apr 1953 – Jun 2013
Kurtosis: 2.24%
Skewness: -0.15%
8.00%
6.00%
4.00%
2.00%
2.00%
1.00%
11.5%
10.5%
9.5%
8.5%
7.5%
6.5%
5.5%
4.5%
3.5%
2.5%
1.5%
0.5%
-0.5%
-1.5%
-2.5%
-3.5%
-4.5%
14.5%
13.0%
11.5%
10.0%
8.5%
7.0%
5.5%
4.0%
2.5%
1.0%
-0.5%
-2.0%
-3.5%
-5.0%
-6.5%
0.00%
-8.0%
0.00%
-5.5%
9.00%
Frequency
-8.0%
-9.5%
0.00%
Page 42
Computed UST Real Rates (cont.)
HCPI Adjusted 20Y Real Rate, Apr 1953 – Jun 2013
CCPI Adjusted 20Y Real Rate, Feb 1957 – Jun 2013
12.00%
14.00%
Mean: 2.63%
June 2013: -3.10%
Mean: 2.74%
June 2013: 0.64%
12.00%
Median: 2.81%
10.00%
Median: 3.15%
Standard Deviation: 3.59%
8.00%
Skewness: -0.09%
Frequency
6.00%
4.00%
Skewness: -0.27%
8.00%
6.00%
HCPI Adjusted 30Y Real Rate, Feb 1977 – Jun 2013
CCPI Adjusted 30Y Real Rate, Feb 1977 – Jun 2013
10.00%
14.00%
June 2013: -2.76%
Mean: 3.27%
12.00%
8.00%
Standard Deviation: 3.87%
7.00%
Kurtosis: 2.47%
Median: 3.39%
Standard Deviation: 2.55%
10.00%
Frequency
Skewness: 0.10%
6.00%
Mean: 3.31%
June 2013: 0.98%
Median: 3.36%
5.00%
4.00%
3.00%
12.0%
11.0%
9.0%
10.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
-4.0%
-6.0%
15.5%
14.0%
12.5%
11.0%
9.5%
8.0%
6.5%
5.0%
3.5%
2.0%
0.5%
-1.0%
-2.5%
-4.0%
-5.5%
0.00%
-7.0%
0.00%
-8.5%
2.00%
-5.0%
4.00%
2.00%
9.00%
Kurtosis: 2.62%
Skewness: -0.06%
8.00%
6.00%
4.00%
2.00%
2.00%
1.00%
0.00%
12.0%
11.0%
10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
-3.0%
16.5%
15.0%
13.5%
12.0%
10.5%
9.0%
7.5%
6.0%
4.5%
3.0%
1.5%
0.0%
-1.5%
-3.0%
-4.5%
-6.0%
0.00%
-7.5%
Frequency
Kurtosis: 2.13%
-4.0%
Frequency
Standard Deviation: 2.70%
10.00%
Kurtosis: 3.29%
Page 43
HCPI vs CCPI Adjusted Real Rates
HCPI Adjusted 10Y Real Rate, Jan 1997 – Jun 2013
CCPI Adjusted 10Y Real Rate, Jan 1997 – Jun 2013
10.00%
12.00%
Median: 2.00%
8.00%
Standard Deviation: 3.76%
7.00%
Kurtosis: 6.34%
Median: 2.29%
10.00%
Standard Deviation: 1.44%
Kurtosis: -0.44%
8.00%
Skewness: 0.60%
6.00%
Mean: 2.18%
June 2013: -0.14%
Mean: 1.88%
June 2013: -3.88%
Frequency
Frequency
9.00%
5.00%
4.00%
3.00%
2.00%
Skewness: -0.25%
6.00%
4.00%
2.00%
1.00%
6.00%
6.50%
6.5%
5.50%
6.0%
5.00%
4.50%
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
-0.50%
-1.00%
-2.00%
14.5%
13.0%
11.5%
10.0%
8.5%
7.0%
5.5%
4.0%
2.5%
1.0%
-0.5%
-2.0%
-3.5%
-5.0%
-6.5%
-8.0%
-1.50%
0.00%
0.00%
TIPS 10Y, Jan 1997 – Jun 2013
14.00%
Mean: 2.16%
12.00%
10.00%
8.00%
June 2013: 0.45%
Median: 2.10%
Standard Deviation: 1.35%
Kurtosis: -0.53%
Skewness: -0.39%
6.00%
4.00%
2.00%
5.5%
5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
0.00%
-2.0%
Frequency
 For the period during which the TIPS 10Y is available
the mean and standard deviation of the CCPI adjusted
rate are 2.18% and 1.44% respectively.
 This is a divergence of 2 percentage points from the
TIPS mean and 9 percentage points from the TIPS
standard deviation. In contrast to the HCPI adjusted
rate, this represents a better estimation of the real rate.
Page 44
US Recession
CCPI 10Y
CCPI 3M
CCPI 20Y
Feb-13
Feb-11
Feb-09
Feb-07
Feb-05
Feb-03
Feb-01
Feb-99
Feb-97
Feb-95
Feb-93
Feb-91
Feb-89
Feb-87
Feb-85
Feb-83
Feb-81
Feb-79
Feb-77
Feb-75
Feb-73
Feb-71
Feb-69
Feb-67
Feb-65
Feb-63
Feb-61
Feb-59
Feb-57
CCPI Adjusted UST Real Rates
20
15
10
5
0
-5
-10
-15
CCPI 30Y
Page 45
1.
US Macroeconomic Outlook
2.
Efficient-Frontier Funding Strategies
3.
A Sixty-Year History of Interest Rates
4.
History of Economic Growth: GDP and the Stock
Market
Page 46
GDP Growth, Jun 1953 – Mar 2013
12.00%
10.00%
March 2013: 1.80%
Mean: 3.06%
Median: 3.10%
Standard Deviation: 3.79%
Kurtosis: 1.32%
Skewness: -0.21%
6.00%
4.00%
2.00%
0.00%
-8.0%
-7.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
Frequency
8.00%
Note: All GDP data are quarterly.
Page 47
S&P 500 Earnings
S&P 500 Nominal Earnings YoY, Dec 1954 – Dec 2012
10.00%
9.00%
December 2012: 2.21%
Mean: 7.50%
Median: 7.75%
Frequency
8.00%
Standard Deviation: 15.29%
7.00%
Kurtosis: 0.51%
6.00%
Skewness: -0.10%
5.00%
4.00%
3.00%
2.00%
1.00%
-36.0%
-32.0%
-28.0%
-24.0%
-20.0%
-16.0%
-12.0%
-8.0%
-4.0%
0.0%
4.0%
8.0%
12.0%
16.0%
20.0%
24.0%
28.0%
32.0%
36.0%
40.0%
44.0%
48.0%
52.0%
0.00%
December 2012: 0.50%
S&P 500 Real Earnings YoY (CCPI Adjusted) , Dec 1958 – Dec 2012
12.00%
Mean: 3.59%
10.00%
Median: 4.54%
Kurtosis: 0.38%
Skewness: 0.00%
December 2012: 0.31%
Mean: 3.94%
Median: 5.43%
Standard Deviation: 14.94%
Standard Deviation: 14.81%
8.00%
Frequency
Kurtosis: 0.56%
Skewness: -0.13%
6.00%
4.00%
2.00%
0.00%
-31.0%
-27.0%
-23.0%
-19.0%
-15.0%
-11.0%
-7.0%
-3.0%
1.0%
5.0%
9.0%
13.0%
17.0%
21.0%
25.0%
29.0%
33.0%
37.0%
41.0%
45.0%
49.0%
15.00%
14.00%
13.00%
12.00%
11.00%
10.00%
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
-39.6%
-35.4%
-31.2%
-27.0%
-22.8%
-18.6%
-14.4%
-10.2%
-6.0%
-1.8%
2.4%
6.6%
10.8%
15.0%
19.2%
23.4%
27.6%
31.8%
36.0%
40.2%
44.4%
48.6%
52.8%
Frequency
S&P 500 Real Earnings YoY (HCPI Adjusted), Dec 1954 – Dec 2012
Page 48
S&P 500 P/E Multiples
Trailing P/E, Jan 1954 – Jun 2013
Current P/E, Jan 2006 – Jun 2013
14.00%
14.00%
Mean: 16.36
Mean: 14.37
June 2013: 14.81
12.00%
Median: 16.46
Median: 14.11
Standard Deviation: 1.41
Standard Deviation: 4.92
10.00%
18.5
18.0
17.5
17.0
15.5
15.0
14.5
14.0
13.5
10.5
32.0
30.0
28.0
26.0
24.0
22.0
20.0
18.0
Next Year P/E, Jan 2006 – Jun 2013
9.00%
8.00%
Mean: 11.42
June 2013: 13.09
Median: 12.11
Standard Deviation: 4.75
7.00%
Kurtosis: -0.65
6.00%
Skewness: 0.18
5.00%
4.00%
3.00%
2.00%
1.00%
25.5
24.0
22.5
21.0
19.5
18.0
16.5
15.0
13.5
12.0
9.0
10.5
7.5
6.0
4.5
3.0
1.5
0.0
0.00%
-1.5
Frequency
16.0
14.0
0.00%
12.0
0.00%
10.0
2.00%
8.0
2.00%
6.0
4.00%
4.0
4.00%
13.0
6.00%
12.5
6.00%
Skewness: 0.26
8.00%
12.0
8.00%
Kurtosis: -0.41
11.5
Frequency
Skewness: 0.36
11.0
Kurtosis: -0.01
2.0
Frequency
10.00%
16.5
12.00%
16.0
June 2013: 15.69
Page 49
S&P 400 Earnings
S&P 400 Nominal Earnings YoY, May 1993 – Jun 2012
14.00%
June 2013: 5.94%
Mean: 11.97%
12.00%
Median: 12.73%
Standard Deviation: 15.83%
Frequency
10.00%
Kurtosis: 1.39%
Skewness: -0.23%
8.00%
6.00%
4.00%
2.00%
-37.5%
-32.5%
-27.5%
-22.5%
-17.5%
-12.5%
-7.5%
-2.5%
2.5%
7.5%
12.5%
17.5%
22.5%
27.5%
32.5%
37.5%
42.5%
47.5%
52.5%
57.5%
62.5%
67.5%
0.00%
S&P 400 Real Earnings YoY (HCPI Adjusted), Dec 1993 – Dec 2012
10.00%
June 2013: 4.52%
14.00%
Mean: 9.21%
12.00%
Median: 9.45%
Standard Deviation: 15.37%
10.00%
Skewness: -0.08%
6.00%
4.00%
Frequency
Kurtosis: 1.33%
8.00%
Mean: 9.56%
Median: 10.03%
Standard Deviation: 15.69%
Kurtosis: 1.43%
Skewness: -0.12%
6.00%
4.00%
2.00%
2.00%
0.00%
0.00%
-38.8%
-34.0%
-29.2%
-24.4%
-19.6%
-14.8%
-10.0%
-5.2%
-0.4%
4.4%
9.2%
14.0%
18.8%
23.6%
28.4%
33.2%
38.0%
42.8%
47.6%
52.4%
57.2%
62.0%
Frequency
8.00%
June 2013: 4.32%
-39.2%
-34.4%
-29.6%
-24.8%
-20.0%
-15.2%
-10.4%
-5.6%
-0.8%
4.0%
8.8%
13.6%
18.4%
23.2%
28.0%
32.8%
37.6%
42.4%
47.2%
52.0%
56.8%
61.6%
12.00%
S&P 400 Real Earnings YoY (CCPI Adjusted) , Dec 1993 – Dec 2012
Page 50
S&P 400 P/E Multiples
Trailing P/E, Dec 1990 – Jun 2013
Current P/E, Jan 1995 – Jun 2013
10.00%
7.00%
June 2013: 20.55
9.00%
Mean: 19.09
Kurtosis: 1.77
6.00%
Skewness: -1.59
Median: 17.37
5.00%
Frequency
7.00%
Mean: 17.34
Standard Deviation: 2.30
Standard Deviation: 5.06
5.00%
4.00%
Kurtosis: -0.09
Skewness: -0.21
4.00%
3.00%
2.00%
3.00%
2.00%
1.00%
1.00%
0.00%
9.50
10.25
11.00
11.75
12.50
13.25
14.00
14.75
15.50
16.25
17.00
17.75
18.50
19.25
20.00
20.75
21.50
22.25
23.00
23.75
24.50
25.25
37.0
35.0
33.0
31.0
29.0
27.0
25.0
23.0
9.00%
Mean: 14.62
June 2013: 15.46
8.00%
Median: 14.93
Standard Deviation: 1.92
7.00%
Kurtosis: -0.09
6.00%
Skewness: -0.48
5.00%
4.00%
3.00%
2.00%
1.00%
21.50
20.75
20.00
19.25
18.50
17.75
17.00
16.25
15.50
14.75
14.00
13.25
12.50
11.75
11.00
10.25
9.50
8.75
0.00%
8.00
19.0
21.0
Next Year P/E, 1995 – Jun 2013
Frequency
17.0
15.0
13.0
9.0
11.0
7.0
5.0
3.0
0.00%
1.0
Frequency
8.00%
June 2013: 18.10
6.00%
Median: 20.43
Page 51
Components of Beta: Insurance Industry
1Y Daily Volatility (Annualized), Jan 2003 – Jul 2013
1
0.95
0.9
0.85
0.8
0.75
0.7
0.65
0.6
0.55
0.5
160%
Standard Deviation
140%
100%
80%
60%
40%
20%
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
0%
US Recession
US Recession
PFG
S&P 500 Life
S&P 500 Prop
5Y Weekly Correlation, Oct 2006 – Jul 2013
PFG
S&P 500 Life
S&P 500 Prop
5Y Weekly Volatility (Annualized), Oct 2006 – Jul 2013
80%
1
70%
Standard Deviation
0.9
0.8
0.7
0.6
0.5
60%
50%
40%
30%
20%
10%
PFG
S&P 500 Life
S&P 500 Prop
US Recession
PFG
S&P 500 Life
Apr-13
Oct-12
Apr-12
Oct-11
Apr-11
Oct-10
Apr-10
Oct-09
Apr-09
Oct-08
Apr-08
Oct-07
Apr-07
Apr-13
Oct-12
Apr-12
Oct-11
Apr-11
Oct-10
Apr-10
Oct-09
Apr-09
Oct-08
Apr-08
Oct-07
Apr-07
US Recession
Oct-06
0%
0.4
Oct-06
Correlation With S&P 500
120%
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Correlation With S&P 500
1Y Daily Correlation, Jan 2003 – Jul 2013
S&P 500 Prop
Note: PFG went public on 10/31/01, therefore the calculated 5-yr corr. and st. dev. data begin 5 years hence in Oct 2006.
Corr. and st. dev. calculated for the % change in list price at the end of the day for the frequency denoted (Daily, Weekly)
Page 52
PFG Deconstructed Rolling Beta
1Y Daily, Oct 2002 – Present
Standard Deviation Target
US Recession
Correlation
Relative Volatility
Apr-13
Oct-12
Apr-12
Oct-11
Apr-11
Oct-10
Apr-10
Oct-09
Apr-09
Oct-08
Apr-08
Oct-07
Apr-07
Oct-06
Apr-06
Standard Deviation Market
Oct-05
Apr-05
Oct-04
Apr-04
Oct-03
Apr-03
Beta  Correlation Target, Market 
Oct-02
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
Calculated Beta
5Y Weekly, Oct 2006 – Present
US Recession
Correlation
Relative Volatility
Apr-13
Oct-12
Apr-12
Oct-11
Apr-11
Oct-10
Apr-10
Oct-09
Apr-09
Oct-08
Apr-08
Oct-07
Apr-07
Oct-06
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
Calculated Beta
Note: Corr. and st. dev. calculated for the % change in list price at the end of the day for the frequency denoted (Daily, Weekly)
Relative Volatility defined as the ratio of the st. dev. of the change in stock price to the st. dev. of the change in the S&P500 Index.
Source: Bloomberg, Ramirez Calculations.
Page 53
Components of Beta: Insurance Industry
Pre-Crisis 1Y Daily Beta Components, Jan 2007 – Jan 2008
1.00
40%
Life Insurance
0.90
35%
0.80
40%
Life Insurance
Property Insurance
35%
0.80
30%
0.70
30%
0.70
0.50
20%
0.40
15%
0.30
10%
0.20
5%
0.00
0%
AFL
LNC
MET
PFG
PL
PRU
SFG
TMK
UNM
ACE
AHL
ALL
CB
CINF
FNF
MCY
ORI
PGR
THG
TRV
WRB
XL
0.10
Correlation
Variation
0.60
25%
0.50
20%
0.40
15%
0.30
10%
0.20
0.10
5%
0.00
0%
AFL
LNC
MET
PFG
PL
PRU
SFG
TMK
UNM
ACE
AHL
ALL
CB
CINF
FNF
MCY
ORI
PGR
THG
TRV
WRB
XL
25%
Variation
0.60
Variation
Correlation
1.00
Property Insurance
Correlation
0.90
Current 1Y Daily Beta Components, Jul 2012 – Jul 2013
Correlation
Variation
Note: Corr. and st. dev. calculated for the annualized % change in list price at the end of the day for the frequency denoted (Daily, Weekly)
Page 54
Components of Beta: Insurance Industry
Pre-Crisis 5Y Weekly Beta Components, Jan 2003 – Jan 2008
1.00
120%
Life Insurance
0.90
100%
0.80
0.70
60%
0.40
40%
0.30
0.20
20%
0.10
100%
80%
0.60
0.50
60%
0.40
Variation
0.50
Property Insurance
0.70
80%
0.60
120%
Life Insurance
0.80
Variation
40%
0.30
0.20
20%
0.10
0%
Correlation
Variation
0.00
0%
AFL
LNC
MET
PFG
PL
PRU
SFG
TMK
UNM
ACE
AHL
ALL
CB
CINF
FNF
MCY
ORI
PGR
THG
TRV
WRB
XL
0.00
AFL
LNC
MET
PFG
PL
PRU
SFG
TMK
UNM
ACE
AHL
ALL
CB
CINF
FNF
MCY
ORI
PGR
THG
TRV
WRB
XL
Correlation
1.00
Property Insurance
Correlation
0.90
Current 5Y Weekly Beta Components, Jul 2008 – Jul 2013
Correlation
Variation
Note: Corr. and st. dev. calculated for the annualized % change in list price at the end of the day for the frequency denoted (Daily, Weekly)
Page 55
Cost of Equity: Current Utility Betas
Regulated Utilities
Median = 0.58
79.8
1.60
Diversified Utilities
Median = 0.6
241.8
1.80
50.1
2-Yr. Daily Betas, Jul 2011 – Jul 2013
Selected E&P and
Merchant Median = 0.96
45
40
1.40
35
1.20
30
1.00
Beta
50
25
0.80
20
0.60
15
0.40
10
0.20
5
0.00
0
Market Cap ($, Bln)
2-Year Beta
+2 Standard Deviations
Market Cap ($, Bln)
-2 Standard Deviations
2.50
Regulated Utilities
Median = 0.5
Diversified Utilities
Median = 0.69
60
79.8
3.00
241.8
5-Yr. Weekly Betas, Jul 2008 – Jul 2013
Selected E&P and
Merchant Median = 1.14
50
2.00
40
1.50
30
1.00
20
0.50
10
0.00
0
Market Cap ($, Bln)
5-Year Beta
+2 Standard Deviations
-2 Standard Deviations
Market Cap ($, Bln)
Beta
As would be
expected, the
median beta
for a sampling
of diversified
utility
companies is
higher than
the median
beta for
regulated
utilities and
lower than the
median beta
for selected
E&P and
merchant
power
companies.
Source: Bloomberg.
Page 56
Cost of Equity: Leverage vs. Beta
2-Yr. Daily Betas, Jul 2011 – Jul 2013
1.00
5-Yr. Weekly Betas, Jul 2008 – Jul 2013
1.00
y = 0.21x + 0.53
R² = 0.01
0.90
0.90
PNM
y = 0.72x + 0.35
R² = 0.10
CNP
PNM
EXC
EIX
0.80
0.70
SRE
PNW
PEG
0.60
EIX
WEC
0.50
POR
VVC
NU
DTE
CNP
GXP
SRE
0.70
NVE
AEE
CMS
NST SCG
WR
AEP
ETR
XEL
Beta
CNL
Beta
ITC
0.80
FE
NEE
ITC
D
EXC
ED
GXP
NVE
DTE
SCG
WR
PNW
CNL
0.60
NU NEE
POR
D
VVC
WEC
XEL
0.50
UIL
CMS
AEP
FE
PPL
UIL
NST
ETR
PPL
DUK
0.40
PEG
AEE
DUK
0.40
PCG
ED
PCG
0.30
0.30
0.20
0.20
0.25
0.30
0.35
0.40
0.45
0.50
Market Value of Leverage (%)
0.55
0.60
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
Market Value of Leverage (%)
 Using MVL as a measure of leverage shows that there is correlation between levered beta and
leverage in the utility space
 Looking at 2-Yr. betas shows a lack of statistical relationship between market risk and leverage
 If MVL increases by 10%, 5-Yr. Beta increases by approximately 7 bps
Source: Bloomberg.
Page 57
Cost of Equity: Unlevered Betas
2-Yr. Daily Unlevered Betas, Jul 2011 – Jul 2013
0.65
0.60
5-Yr. Weekly Unlevered Betas, Jul 2008 – Jul 2013
0.65
y = -0.42x + 0.59
R² = 0.10
0.60
CNL
y = -0.10x + 0.48
R² = 0.00
0.55
ITC
PNM
0.50
PNW
SRE
PEG
0.45
EIX
WEC
CNP
NU
0.40
ITC
D
0.35
ED
0.30
DUK
GXP
AEE
DTE
NEE
NST
WR
XEL
NVE
SCG
CMS
AEP
ETR
EXC
UIL
SRE
PEG
CNL
0.45
0.40
AEE
DTE
POR
VVC
NU
SCG
NVE
NEE
WR
AEP
GXP
CMS
D
FE
NST
WEC
0.35
PPL
UIL
DUK
0.30
ETR
XEL
ED
PPL
PCG
0.25
FE
0.50
CNP
EXC
PNW
POR
VVC
Unlevered Beta
Unlevered Beta
PNM
EIX
0.55
0.25
0.20
PCG
0.20
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
Market Value of Leverage (%)
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
Market Value of Leverage (%)
 Unlevering 5-Yr. Utility sector Betas produces coefficients that are close to zero,
which suggests that calculating unlevered Beta fairly estimates the expected effect
of leverage on Beta
 BL = BU x [1+ (1-T) x (D/E)]
Source: Bloomberg.
Page 58