Management’s discussion and analysis JPMorgan Chase & Co The following table summarizes the aggregate notional amounts and the reported derivative receivables (i. e. , the MTM or fair value of the derivative contracts after taking into account the effects of legally enforceable master netting agreements) at each of the dates indicated: Notional amounts and derivative receivables marked to market (“MTM”)
## Table 0 ##
(a) The notional amounts represent the gross sum of long and short third-party notional derivative contracts, excluding written options and foreign exchange spot contracts, which significantly exceed the possible credit losses that could arise from such transactions.
For most derivative transactions, the notional principal amount does not change hands; it is used simply as a reference to calculate payments.
(b) The Firm held $33 billion of collateral against derivative receivables as of December 31, 2005, consisting of $27 billion in net cash received under credit support annexes to legally enforceable master netting agreements, and $6 billion of other liquid securities collateral.
The benefit of the $27 billion is reflected within the $50 billion of derivative receivables MTM.
Excluded from the $33 billion of collateral is $10 billion of collateral delivered by clients at the initiation of transactions; this collateral secures exposure that could arise in the derivatives portfolio should the MTM of the client’s transactions move in the Firm’s favor.
Also excluded are credit enhancements in the form of letters of credit and surety receivables.
(c) The Firm held $41 billion of collateral against derivative receivables as of December 31, 2004, consisting of $32 billion in net cash received under credit support annexes to legally enforceable master netting agreements, and $9 billion of other liquid securities collateral.
The benefit of the $32 billion is reflected within the $66 billion of derivative receivables MTM.
Excluded from the $41 billion of collateral is $10 billion of collateral delivered by clients at the initiation of transactions; this collateral secures exposure that could arise in the derivatives portfolio should the MTM of the client’s transactions move in the Firm’s favor.
Also excluded are credit enhancements in the form of letters of credit and surety receivables.
The MTM of derivative receivables contracts represents the cost to replace the contracts at current market rates should the counterparty default.
When JPMorgan Chase has more than one transaction outstanding with a counterparty, and a legally enforceable master netting agreement exists with that counterparty, the netted MTM exposure, less collateral held, represents, in the Firm’s view, the appropriate measure of current credit risk.
While useful as a current view of credit exposure, the net MTM value of the derivative receivables does not capture the potential future variability of that credit exposure.
To capture the potential future variability of credit exposure, the Firm calculates, on a client-by-client basis, three measures of potential derivatives-related credit loss: Peak, Derivative Risk Equivalent (“DRE”) and Average exposure (“AVG”).
These measures all incorporate netting and collateral benefits, where applicable.
Peak exposure to a counterparty is an extreme measure of exposure calculated at a 97.5% confidence level.
However, the total potential future credit risk embedded in the Firm’s derivatives portfolio is not the simple sum of all Peak client credit risks.
This is because, at the portfolio level, credit risk is reduced by the fact that when offsetting transactions are done with separate counterparties, only one of the two trades can generate a credit loss, even if both counterparties were to default simultaneously.
The Firm refers to this effect as market diversification, and the Market-Diversified Peak (“MDP”) measure is a portfolio aggregation of counterparty Peak measures, representing the maximum losses at the 97.5% confidence level that would occur if all counterparties defaulted under any one given market scenario and time frame.
Derivative Risk Equivalent (“DRE”) exposure is a measure that expresses the riskiness of derivative exposure on a basis intended to be equivalent to the riskiness of loan exposures.
The measurement is done by equating the unexpected loss in a derivative counterparty exposure (which takes into consideration both the loss volatility and the credit rating of the counterparty) with the unexpected loss in a loan exposure (which takes into consideration only the credit rating of the counterparty).
DRE is a less extreme measure of potential credit loss than Peak and is the primary measure used by the Firm for credit approval of derivative transactions.
Finally, Average exposure (“AVG”) is a measure of the expected MTM value of the Firm’s derivative receivables at future time periods, including the benefit of collateral.
AVG exposure over the total life of the derivative contract is used as the primary metric for pricing purposes and is used to calculate credit capital and the Credit Valuation Adjustment (“CVA”), as further described below.
Average exposure was $36 billion and $38 billion at December 31, 2005 and 2004, respectively, compared with derivative receivables MTM net of other highly liquid collateral of $44 billion and $57 billion at December 31, 2005 and 2004, respectively.
The graph below shows exposure profiles to derivatives over the next 10 years as calculated by the MDP, DRE and AVG metrics.
All three measures generally show declining exposure after the first year, if no new trades were added to the portfolio.
Notes to consolidated financial statements 210 JPMorgan Chase & Co. /2010 Annual Report Estimated future benefit payments The following table presents benefit payments expected to be paid, which include the effect of expected future service, for the years indicated.
The OPEB medical and life insurance payments are net of expected retiree contributions.
## Table 1 ##
Note 10 – Employee stock-based incentives Employee stock-based awards In 2010, 2009, and 2008, JPMorgan Chase granted long-term stock-based awards to certain key employees under the 2005 LongTerm Incentive Plan (the “2005 Plan”).
The 2005 Plan became effective on May 17, 2005, and was amended in May 2008.
Under the terms of the amended 2005 plan, as of December 31, 2010, 113 million shares of common stock are available for issuance through May 2013.
The amended 2005 Plan is the only active plan under which the Firm is currently granting stock-based incentive awards.
In the following discussion, the 2005 Plan, plus prior Firm plans and plans assumed as the result of acquisitions, are referred to collectively as the “LTI Plans,” and such plans constitute the Firm’s stock-based incentive plans.
Restricted stock units (“RSUs”) are awarded at no cost to the recipient upon their grant.
RSUs are generally granted annually and generally vest at a rate of 50% after two years and 50% after three years and convert into shares of common stock at the vesting date.
In addition, RSUs typically include full-career eligibility provisions, which allow employees to continue to vest upon voluntary termination, subject to post-employment and other restrictions based on age or service-related requirements.
All of these awards are subject to forfeiture until vested.
An RSU entitles the recipient to receive cash payments equivalent to any dividends paid on the underlying common stock during the period the RSU is outstanding and, as such, are considered participating securities as discussed in Note 25 on page 269 of this Annual Report.
Under the LTI Plans, stock options and stock appreciation rights (“SARs”) have generally been granted with an exercise price equal to the fair value of JPMorgan Chase’s common stock on the grant date.
The Firm typically awards SARs to certain key employees once per year, and it also periodically grants discretionary stock-based incentive awards to individual employees, primarily in the form of both employee stock options and SARs.
The 2010, 2009 and 2008 grants of SARs to key employees vest ratably over five years (i. e. , 20% per year).
The 2010 grants of SARs contain full-career eligibility provisions; the 2009 and 2008 grants of SARs do not include any full-career eligibility provisions.
SARs generally expire 10 years after the grant date.
The Firm separately recognizes compensation expense for each tranche of each award as if it were a separate award with its own vesting date.
Generally, for each tranche granted, compensation expense is recognized on a straight-line basis from the grant date until the vesting date of the respective tranche, provided that the employees will not become full-career eligible during the vesting period.
For awards with full-career eligibility provisions and awards granted with no future substantive service requirement, the Firm accrues the estimated value of awards expected to be awarded to employees as of the grant date without giving consideration to the impact of post-employment restrictions.
For each tranche granted to employees who will become full-career eligible during the vesting period, compensation expense is recognized on a straight-line basis from the grant date until the earlier of the employee’s fullcareer eligibility date or the vesting date of the respective tranche.
The Firm’s policy for issuing shares upon settlement of employee stock-based incentive awards is to issue either new shares of common stock or treasury shares.
During 2010, 2009 and 2008, the Firm settled all of its employee stock-based awards by issuing treasury shares.
In January 2008, the Firm awarded to its Chairman and Chief Executive Officer up to 2 million SARs.
The terms of this award are distinct from, and more restrictive than, other equity grants regularly awarded by the Firm.
The SARs, which have a 10-year term, will become exercisable no earlier than January 22, 2013, and have an exercise price of $39.83.
The number of SARs that will become exercisable (ranging from none to the full 2 million) and their exercise date or dates may be determined by the Board of Directors based on an annual assessment of the performance of both the CEO and JPMorgan Chase.
The Firm recognizes this award ratably over an assumed five-year service period, subject to a requirement to recognize changes in the fair value of the award through the grant date.
The Firm recognized $4 million, $9 million and $1 million in compensation expense in 2010, 2009 and 2008, respectively, for this award.
Other-than-temporary impairment The following table presents credit losses that are included in the securities gains and losses table above.
## Table 2 ##
a) For initial OTTI, represents the excess of the amortized cost over the fair value of AFS debt securities.
For subsequent OTTI of the same security, represents additional declines in fair value subsequent to the previously recorded OTTI, if applicable.
(b) Represents the credit loss component of certain prime mortgage-backed securities and obligations of U. S.  states and municipalities for 2010, and certain prime and subprime mortgage-backed securities and obligations of U. S.  states and municipalities for 2009 that the Firm does not intend to sell.
Subsequent credit losses may be recorded on securities without a corresponding further decline in fair value if there has been a decline in expected cash flows.
(c) Excluded from this table are OTTI losses of $7 million that were recognized in income in 2009, related to subprime mortgage-backed debt securities the Firm intended to sell.
These securities were sold in 2009, resulting in the recognition of a recovery of $1 million.
Changes in the credit loss component of credit-impaired debt securities The following table presents a rollforward for the years ended December 31, 2010 and 2009, of the credit loss component of OTTI losses that were recognized in income related to debt securities that the Firm does not intend to sell.
## Table 3 ##
Gross unrealized losses Gross unrealized losses have generally decreased since December 31, 2009, due primarily to market spread improvement and increased liquidity, driving asset prices higher.
However, gross unrealized losses on certain securities have increased, including on certain corporate debt securities, which are primarily government-guaranteed positions that experienced credit spread widening.
As of December 31, 2010, the Firm does not intend to sell the securities with a loss position in AOCI, and it is not likely that the Firm will be required to sell these securities before recovery of their amortized cost basis.
Except for the securities reported in the table above for which credit losses have been recognized in income, the Firm believes that the securities with an unrealized loss in AOCI are not other-than-temporarily impaired as of December 31, 2010.
Following is a description of the Firm’s principal security investments with the most significant unrealized losses as of December 31, 2010, and the key assumptions used in the Firm’s estimate of the present value of the cash flows most likely to be collected from these investments.
Mortgage-backed securities – Prime and Alt-A nonagency As of December 31, 2010, gross unrealized losses related to prime and Alt-A residential mortgage-backed securities issued by private issuers were $250 million, all of which have been in an unrealized loss position for 12 months or more.
Approximately 70% of the total portfolio (by amortized cost) are currently rated below investment-grade; the Firm has recorded other-than-temporary impairment losses on 55% of the below investment-grade positions.
In analyzing prime and Alt-A residential mortgage-backed securities for potential credit losses, the Firm utilizes a methodology that focuses on loan-level detail to estimate future cash flows, which are then allocated to the various tranches of the securities.
The loanlevel analysis primarily considers current home value, loan-to-value (“LTV”) ratio, loan type and geographical location of the underlying property to forecast prepayment, home price, default rate and loss severity.
The forecasted weighted average underlying default rate on the positions was 21% and the related weighted average loss severity was 50%.
Based on this analysis, an OTTI loss of $6 million was recognized in 2010 related to securities that experienced increased delinquency rates associated with specific collateral types and origination dates.
Overall losses have decreased since December 31, 2009, with the recovery in security prices resulting from increased demand for higher-yielding asset classes and a deceleration in the pace of home price declines due in part to the U. S.  government programs to facilitate financing and to spur home purchases.
The unrealized loss of $250 million is considered temporary, based on management’s assessment that the estimated future cash flows together with the credit enhancement levels for those securities remain sufficient to support the Firm’s investment.
The credit enhancements associated with the below investment-grade and investment-grade positions are 9% and 24%, respectively.
Asset-backed securities – Collateralized loan obligations As of December 31, 2010, gross unrealized losses related to CLOs were $210 million, of which $200 million related to securities that were in an unrealized loss position for 12 months or more.
Overall losses have decreased since December 31, 2009, mainly as a result of lower default forecasts and spread tightening across various asset classes.
Substantially all of these securities are rated “AAA,” “AA” and “A” and have an average credit enhancement of 30%.
Credit enhancement in CLOs is primarily in the form of subordination, which is a form of structural credit enhancement where realized losses associated with assets held by an issuing vehicle are allocated to issued tranches considering their relative seniority.
The key assumptions considered in analyzing potential credit losses were underlying loan and debt security defaults and loss severity.
Based on current default trends, the Firm assumed collateral default rates of 2.1% for 2010 and 5% thereafter.
Further, loss severities were assumed to be 48% for loans and 78% for debt securities.
Losses on collateral were estimated to occur approximately 18 months after default.
Pledged assets At December 31, 2010, assets were pledged to collateralize repurchase agreements, other securities financing agreements, derivative transactions and for other purposes, including to secure borrowings and public deposits.
Certain of these pledged assets may be sold or repledged by the secured parties and are identified as financial instruments owned (pledged to various parties) on the Consolidated Balance Sheets.
In addition, at December 31, 2010 and 2009, the Firm had pledged $288.7 billion and $344.6 billion, respectively, of financial instruments it owns that may not be sold or repledged by the secured parties.
The significant components of the Firm’s pledged assets were as follows.

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As of December 31,	Notional amounts(a)	Derivative receivables MTM
(in billions)	2005	2004	2005	2004
Interest rate	$38,493	$37,022	$30	$46
Foreign exchange	2,136	1,886	3	8
Equity	458	434	6	6
Credit derivatives	2,241	1,071	4	3
Commodity	265	101	7	3
Total	$43,593	$40,514	50	66
Collateral held againstderivative receivables	NA	NA	-6	-9
Exposure net of collateral	NA	NA	$44(b)	$57(c)

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Year ended December 31,	U.S. defined benefit pension plans	Non-U.S. defined benefit pension plans	OPEB before Medicare Part D subsidy	Medicare Part D subsidy
(in millions)
2011	$1,001	$84	$99	$10
2012	1,011	92	97	11
2013	587	98	95	12
2014	593	102	94	13
2015	592	111	92	14
Years 2016—2020	3,013	640	418	78

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Year ended December 31, (in millions)	2010	2009
Debt securities the Firm does not intend tosell that have credit losses
Total other-than-temporary impairmentlosses(a)	$-94	$-946
Losses recorded in/(reclassified from)other comprehensive income	-6	368
Credit losses recognized in income(b)(c)	$-100	$-578

', '

Year ended December 31, (in millions)	2010	2009
Balance, beginning of period	$578	$—
Additions:
Newly credit-impaired securities	—	578
Increase in losses on previously credit-impairedsecurities	94	—
Losses reclassified from other comprehensiveincome on previously credit-impaired securities	6	—
Reductions:
Sales of credit-impaired securities	-31	—
Impact of new accounting guidance relatedto VIEs	-15	—
Balance, end of period	$632	$578

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Question: for the derivative contracts , assuming an average contract life of 10 years , what would annual exposure be in us$ billion at december 31 , 2005 on derivative receivables?
Answer: 3.6