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CJt I~ gg 

[ADDRESSEE] 

Dear 

The [Issuer.] has requested the ~taff of the Commodity 

Futures Trading Commission ( 11 Cornmission11 ) to inform [the Issuer] 

whether the staff would recommend that the Commission take action 

against [the Issuer's] proposed issuance of notes designated as 

~ • • ( 11Notes"). That request was made at a meeting with 

Commission staff on January 14, 1988. Based upon the 

characteristics of the Notes, which resemble yen-denominated debt 

instruments, and the other matters discussed below, the staff has 

determined that it will not recommend to the Commission any 

enforcement action based,upon the issuance of the proposed Notes. 

[The Issuer], the proposed issuer, is a stockholder-owned 

corporation chartered by an Act of the Congress . • . . 

All securities issued by [the Issuer], which carry ""AAA" 

investment grade ratings from various rating agencies, are deemed 

to be exempt securities under the laws administered by the 

Sec~rities and Exchange commission (SEC), to the same extent as 

obligations of the United States. 

From discussions with [the Issuer] and the materials 

included in the January 19, 1988 Memorandum, in particular the 

Offering· Circular, the staff understands the proposed offering to 

be as follows. [The Issuer] will issue unsecured, non-callable, 

registered notes having a five-year maturity period. The Notes; 

issued in minimum denominations of U.S. $[ ] will bear 

interest at a specified rate of return payable in u.s. dollars, 

semiannually. At maturity, each $[ ) face value of the 

principal amount of the Note will be payable in an amount equal 

to the formula of u.s. $[ ] minus the U.S. dollar equivalent 

of [ ] Japanese yen, or other rate reflective of market 

c'ondit"ions at the time of issuance. The appropriate exchange 

rate at the maturity of the Notes will be determined by an 

average dealer price quotation. The Notes will be issued 
Pa.ge 2 

pursuant to an Offering Circular which is consistent with 

disclosure requirements of the SEC applicable to registered 

issuers. The Notes will 'be marketed to the public as debt 

security instruments and not as having the "beneficial 

characteristics of commodity options or futures contracts." 

(January 19 Memorandum at 14). [The Issuer] further represents 

that it fully hedges its foreign currency risk in the forward 

market simultaneously with its issuance of debt that carries such 

a risk. 

The proposed Notes may be characterized as "hybrid 

instruments," in that they combine certain elements of 

traditional commodity interests with those of debt instruments. 

The combination of commodity interests with instruments which 

traditionally.have been viewed as debt-like creates certain risks 

which, in futures, options on futures, and options on certain 

physical transactions, are addressed by futures exchange or 

Commission rules. 

·.Although·.[ the Issuer]· contends tnat the. Notes are not 

"classic" futures contracts (January 19 Memorandum ·at 4), neither 

are they "classic" debt instruments. The Nqtes have two distinct 

components. First, they contain a traditional debt component 

which provides for the $emiannual payment of interest. For 

'example, similar Notes issued by [the Issuer) ir). ••• paid 

interest to the holder at a rate of • . • per annum in return for 

use of the loan capital extended for the term thereof, in that 

case ..• years. The coupon yield on this component of the 

transaction was higher than the market rate for a comparable pure 

debt instrument issued or offered by [the Issuer] or a comparable 

issuer. The currency-indexed component of the Notes enables the 

Note purchaser to participate in the change in the value of the 

yen versus the dollar calculated as an adjustment to the 

principal amount of the Note when due, in effect either reducing 

·or increasing the payment at maturity. · 

On December 11, 1987, the Commission issued an advance 

notice of proposed rulemaking which requested comment from the 

public on, among other matters, the commodity-related risks 

associated with hybrid instruments in contemplation of developing 

a regulatory framework for the treatment of such instruments. 

52 F .R. 47022. ("Advance. Notice 11 ). The comment period, which 

was extended, ended on April 11, 1988. 53 F.R. 2510 (January 28, 

i988). In view of the fact that the Advance Notice remains 

pending and that the Commission has not reached a final 

determination with respect to the proposals set forth therein, 

the staff believes that it is appropriate, in limited circumstances· such as this, to address certain instruments on a 

case-by-case basis. 
·. 

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Page 3 

Although the Notes are not specifically encompassed by the 

Advance Notice, the staff believes' that the no-action position 

set forth herein is not inconsistent with the basic framework of 

analysis contained in the Advance Notice as outlined below. 

Under the Advance Notice proposal certain otherwise regulated 

hybrid instruments with "incidental 11 commodity option components 

would be subject to exemption from the Commission's rules subject 

to specified conditions. Although the risk/retu~n characteristics· of the Notes, despite their "capping" feature, cannot be 

character'ized readily as those of options, it is nevertheless 

instructive to review the conditions for exemption set forth in 

the Advance Notice. ·· · 

The Advance Notice proposed several tests to establish ·· whether the commodity option component of a hybrid option 

instrument is merely incidental to the overall nature of the 

instrument, including: (1) the term to maturity of the 

instrument, (2) the commodity-based return vis-a-vis the return 

of the entire instrument, and (3) the relation of the instrument 

to its offeror's line.of bq.siness. In any event, hybrid 

instruments would not'be eligible for exemptiori·where the 

"predominant purpose [of the transaction is] the conveyance of an 

interest in an option on a commodity or the functional equivalent 

of such a corrunodity interest." 52 F.R. 47026. Ih the Advance 

Notice, the Commission also sought comment on further specific 

requirements for affording an exemption from full regulation by 

the Commission. These included requirements that the offeror of 

a hybrid instrument have a net worth of at least $100 million; 

that it maintain cover for or reserves of the commodity; and that 

the instrument be otherwise regulated by another federal 

authority. 

Based upon the representations of [the Issuer], the offering, 

documents, and the staff's review, it appears that the-commodity 

interest component of the Note proposed to be offered by [the 

Issuer] distributes returns between the lender and the borrower 

based upon the direction and magnitude of the price change in the 

Japanese yen relative to the U.S. dollar. 1/ The Note can be 

viewed as a coupon~bearing instrument where repayment of 

1/ For example, if at maturity the value of the yen is equal to 

the benchmark value of yen per dollar, there is no gain 

or loss for the holder of the yen-indexed feature of the 

Note, and the bond principal of $ is paid at maturity. 

If the yen weakens significantly against the dollar, for 

example to yen per dollar, then the 

(Footnote Continued)' 
.•. 

. ~ . t'1'• 

Page 4 

the principal has been indexed to the yen on a one-to-one basis. 

The traditional coupon component of the Notes provides an 

interest payment denominated in dollars and the principal is 

repaid based on yen value, such that the Notes provide a fixed 

interest payment together with a principal return resembling, in 

many respects, a yen-denominated bond which, when converted into 

dollars, reflects the prevailing exchange rate. As a result of 

this indexation feature, the maximum gain or loss on the 

commodity component is $ , an amount equivalent to the bond 

principal amount. Consequently, the commodity-related component 

of the transaction, which results in a one-to-one increase or 

reduction in payable principal in accordance with the yen 

exchange rate, is reflective of a foreign currency-denominated 

debt interest. In addition, although the Notes contain certain 

incidental futures-type elements affecting the distribution of 

risk, their other characteristics preclude ready characterization 

pf the Notes as futures equivalents. 

(Footnote Continued) 

yen-indexed component of the Note will yield $' ·($ 

maxi~um gain from the yen depreciation minus the remaining 

$ value of the yen) in addition to the $ principal 

repayment. The Note holder's position would achieve its 

maximum profit of $ in addition to the $ principal 

repayment if the yen became worthless against the U.S. 

dollar~ Thus, in the case of a depreciation of the yen, the 

total payment at. maturity of the Note would be equal to the 

principal repayment of $ plus the gain on the yen-indexed 

component of the hybrid instrument, such as the $ or 

$ in the above examples. 

In contrast, the holder of the Note loses if the yen 

strengthens relative to the dollar. However, these losses 

are capped so as to equal, at most, the $ principal 

payment.· If the yen strengthened against the dollar from 

the initial contract value of yen per dollar to, for 

example, yen per dollar, then the amount of principal 

payable at maturity is $ minus the dollar value of 

yen or$ (i.e., yen divided by yen per dollar) f?r 

a loss of $ , with the $ principal repayment decreased 

by that amount. Expressed differently, the formula for the 

payment at maturity o·f the Note is $ minus the $ yen 

value for a total of $ 
.. .. ·~ .. 

Page 5 

Due to the various characteristics of the Notes, the staff 

will nat recommend to the Commission any enforcement action under 

Section 4(a) of the Commodity Exchange Act based upon the 

issuance of the proposed Notes. The staff position also is based 

upon the representations of the issuer, including those relating 

to the marketing and disclosure that will accompany the proposed 

offering, the particular terms and conditions of the proposed 

Notes, and upon agreement by [the Issuer] to submit to special 

calls for information with respect to the Notes and the matters 

addressed herein. 

This position does not excuse [the Issuer] from complying 

. with any·otherwise applicable provisions of the Commodity 

Exchange Act, nor does it address any other offering or proposed 

offering by [the Issuer]. This position is based upon the facts 

and representations contained in [the Issuer's] letter and 

conversations with the staff. Any different, omitted or changed 

facts or conditions might require a different conclusion. 

Moreover, it should be noted that this position is that of the 

staff and is not binding upon the Commission and that any 

subsequent determination by the Commission with regard to the 

outstanding Advance Notice may require a reconsideratio'n qf this 

position for subsequent offerings. 

cc: 

Sincerely, 

Marshall E. Hanbury 

Co-Chairman 

Commodity Futures 

Trading Commission 

Off-Exchange Task Force 

Paula A. Tosini 

Co-Chairman 

Commodity Futures 

Trading Commission 

Off-Exch.ange Task Force 

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