exv10w1



 





Exhibit 10.1




INVESTMENT MANAGEMENT AGREEMENT



THIS INVESTMENT MANAGEMENT AGREEMENT (this “Agreement”) is entered into
this 8th day of June, 2004 by and between FBR Investment Management, Inc., a
Delaware corporation and registered investment adviser (“Adviser”), and
Aether Systems, Inc., a Delaware corporation (“Client”).




     WHEREAS, Client wishes to employ Adviser to provide certain portfolio
investment management services to Client, including such trading as is
consistent with Client’s Investment Objective and Focus as set forth in
Appendix A, with respect to an investment account (the “Account”)
of Client comprised of residential mortgage-backed securities (“RMBS”),
and Adviser desires to provide such services to Client with respect to the
Account, on the terms and conditions set forth herein.



     NOW, THEREFORE, in consideration of the promises and mutual covenants and
conditions set forth herein, and for other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto
hereby agree as follows.


Section 1. Investment Management Services. Adviser will manage the investment
of securities and cash in Client’s Account on a commercially prudent basis,
subject to the direction of Client and the terms and conditions hereof.
Without limiting the foregoing, Adviser shall perform such services as may be
required from time to time for the management of the Account as Client shall
reasonably request or Adviser deems appropriate under the circumstances,
including, without limitation, the following (collectively, the
“Services”):




     (a) identifying, recommending and implementing investment and funding
criteria and strategies and return and risk management strategies for Account;



     (b) representing Client with mortgage banking parties in connection with
the purchase and commitment to purchase or sell RMBS and implementation of
Client’s leveraging policy;



     (c) monitoring and providing to Client on an ongoing basis price
information and other data obtained from nationally recognized dealers that
maintain markets in RMBS and providing data and advice to Client in connection
with the identification of such dealers;



     (d) managing the day-to-day operations of the Account, to the extent not
performed by the Custodian pursuant to the Trust Agreement, and performing and
supervising the performance of such other administrative functions necessary in
the management of the Account as may be reasonably agreed upon by Adviser and
Client, including the collection of revenues and the payment of debts and
obligations incurred in connection with the Account;



     (e) evaluating, recommending and implementing hedging strategies;



 









 





     (f) taking commercially reasonable actions to ensure that there are
sufficient controls in place at all times to establish and maintain the
completeness and accuracy of Account information;



     (g) providing such information to Client as it may reasonably request in
order for Client to prepare any filing required by the Securities and Exchange
Commission (the “SEC”) or any exchange or quotation system on which
Client’s securities are listed or quoted to be filed by Client;



     (h) providing such information that Client may reasonably request to
comply with applicable law, including the Sarbanes-Oxley Act of 2002 and taking
reasonably requested actions necessary for the maintenance of Client’s
exemption under the Investment Company Act of 1940, as amended, and the rules
and regulation thereunder (the “1940 Act”); and



     (i) cooperating
reasonably with consultants, auditors, accountants, attorneys
and other designated representatives of Client in connection with any service
provided hereunder.


Client agrees to inform Adviser promptly in writing of any material changes in
Client’s investment objectives or financial circumstances which may affect the
manner in which Client’s assets should be invested, and this Agreement shall be
amended accordingly. In the event Client notifies Adviser of material changes
to its investment objectives or financial circumstances, Adviser shall have a
reasonable period of time, not to exceed 15 days, in which to advise Client of
the amount of time required to alter the manner in which the Account is
invested and the Services are provided to meet such changed investment
objectives. Client understands that Adviser’s duties as described herein relate
solely to the management of the Account and not to any other aspect of Client’s
business, and Adviser is not responsible for Client’s compliance with any laws
or regulations applicable to Client.



Section 2. Portfolio Management Services. Subject to the direction and
oversight of Client and the guidelines set forth in Appendix A and
Appendix D, Client hereby delegates trading authority over the Account
to Adviser. Client acknowledges and agrees that Adviser will be solely
responsible for the investment and reinvestment of the assets in the Account in
accordance with this Agreement, including without limitation, Appendix A
and Appendix D, each as amended from time to time. Adviser will also be
solely responsible for the execution of securities transactions through brokers
or dealers.



Section 3. Account Reports. Pursuant to an agreement between Client and the
Account’s Custodian (as defined in Section 10(a)) to be agreed upon by client
and the Custodian, Client will receive from the Custodian periodic reports
reflecting transaction dates, costs, and current market value of assets of the
Account. Adviser will provide to Client weekly, monthly, quarterly and annual
written reports based on information obtained from the Custodian, specifying
the amount of assets and liabilities in the Account which consist of whole pool
RMBS interests (“Qualifying Interests”) and non-whole pool RMBS interests, other real estate securities
(“Non-qualifying Interests”) and




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other investments in the Account.
Adviser shall also provide Client such other Account information concerning the
calculation of Fees as set forth in Appendix B as Client may reasonably
request, as well as other information that Client reasonably requests and that
can be obtained without commercially unreasonable efforts. Client understands
the information provided by Adviser will not be prepared in accordance with
generally accepted accounting principles.



Section 4. Adviser Obligations. (a) Adviser shall refrain from any action
which would violate any law, rule or regulation of any governmental body or
agency having jurisdiction over the Account or which would otherwise not be
permitted by Client’s governing documents or the terms hereof.




     (b) Adviser shall require each seller or transferor of RMBS to the Account
to make such representations and warranties regarding such mortgage securities
or mortgage loans as may be, in the judgment of Adviser, necessary, advisable
and appropriate. In addition, Adviser shall take such other action as it deems
necessary, advisable or appropriate with regard to the protection of the
Account’s investments.



     (c) Adviser shall operate in compliance with the provisions of the
Investment Advisers Act of 1940, as amended, and the rules and regulations
thereunder (the “Advisers Act”) applicable to the performance of
Adviser’s duties hereunder and shall remain registered under the Advisers Act
at all times during the term of this Agreement.



     (d) Adviser shall operate in compliance with the provisions of the
Commodities Exchange Act, as amended, and the rules and regulations thereunder
(the “Commodities Act”) applicable to the performance of Adviser’s
duties hereunder and shall remain registered as a commodity pool operator under
the Commodities Act at all times during the term of this Agreement.



     (e) Adviser shall maintain appropriate books of account and records
relating to services performed hereunder, and such books of account and records
shall be accessible for inspection by representatives of Client at any time
during normal business hours.



     (f) Upon notice from Client that Client intends to rely on section 3(c)(5)
of the 1940 Act, Adviser shall conduct the investment activities of Client in
such a manner as to establish promptly and maintain Client’s exemption under
section 3(c)(5) of the 1940 Act as provided in Appendix A.



     (g) When executing transactions for the Account and selecting brokers and
dealers, Adviser shall endeavor to obtain commercially reasonable terms, taking
into account the market and price for the security, the financial condition and
execution capability of the broker or dealer and the reasonableness of the
commission.



     (h) Adviser shall obtain and maintain a fidelity bond in an amount and
with an insurer that is reasonably acceptable to Client which shall cover,
among other things, losses resulting from the dishonesty or fraudulent acts of Adviser’s
employees. The cost of such bond shall be borne by Adviser.



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Section 5. Adviser Representations and Warranties. (a) Adviser is duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its formation, has the corporate power to own its assets and to
transact the business in which it is now engaged and is duly qualified to do
business and is in good standing under the laws of each jurisdiction where its
ownership or lease of property or the conduct of its business require such
qualification, except for failures to be so qualified, authorized or licensed
that could not in the aggregate have a material adverse effect on the business
operations, assets or financial conditions of Adviser. Adviser does not do
business under any fictitious business name. Adviser is registered as an
investment adviser under the Advisers Act.




     (b) Adviser has the corporate power and authority to execute, deliver and
perform this Agreement and all obligations required hereunder and has taken all
necessary action to authorize this Agreement and the execution, delivery and
performance of this Agreement and all obligations required hereunder. No
consent of any other person, and no license, permit, approval or authorization
of, exemption by, notice or report to, or registration, filing or declaration
with, any governmental authority, is required to be obtained by Adviser in
connection with this Agreement or the execution, delivery, performance,
validity or enforceability of this Agreement and all obligations required
hereunder. This Agreement has been, and each instrument or document required
hereunder will be, executed and delivered by a duly authorized agent of
Adviser. This Agreement constitutes, and each instrument or document required
hereunder when executed and delivered hereunder will constitute, the legally
valid and binding obligation of Adviser enforceable against Adviser in
accordance with its terms.



     (c) The execution, delivery and performance of this Agreement and the
documents or instruments required hereunder do not and will not violate any
provision of any existing law or regulation binding on Adviser, or any order,
judgment, award or decree of any court, arbitrator or governmental authority
binding on Adviser, or any securities issued by Adviser or of any mortgage,
indenture, lease, contract or other agreement, instrument or undertaking to
which Adviser is a party or by which Adviser or any of its assets may be bound,
the violation of which would have a material adverse effect on the business
operations, assets or financial condition of Adviser and will not result in, or
require, the creation or imposition of any lien on any of its property assets
or revenues pursuant to the provisions of any such mortgage indenture, lease,
contract or other agreement, instrument or undertaking.


Section 6. Client Representations and Warranties. (a) Client is duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its formation, has the corporate power to own its assets and to
transact the business in which it is now engaged and is duly qualified to do
business and is in good standing under the laws of each jurisdiction where its
ownership or lease of property or the conduct of its business require such
qualification, except for failures to be so qualified, authorized or licensed
that could not in the aggregate have a material adverse effect on the business
operations, assets or financial conditions of Client. Client does not do business under
any fictitious business name.




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     (b) Client has the corporate power and authority to execute, deliver and
perform this Agreement and all obligations required hereunder and has taken all
necessary action to authorize this Agreement and the execution, delivery and
performance of this Agreement and all obligations required hereunder. No
consent of any other person, and no license, permit, approval or authorization
of, exemption by, notice or report to, or registration, filing or declaration
with, any governmental authority, is required to be obtained by Client in
connection with this Agreement or the execution, delivery, performance,
validity or enforceability of this Agreement and all obligations required
hereunder. This Agreement has been, and each instrument or document required
hereunder will be, executed and delivered by a duly authorized agent of Client.
This Agreement constitutes, and each instrument or document required hereunder
when executed and delivered hereunder will constitute, the legally valid and
binding obligation of Client enforceable against Client in accordance with its
terms.



     (c) The execution, delivery and performance of this Agreement and the
documents or instruments required hereunder do not and will not violate any
provision of any existing law or regulation binding on Client, or any order,
judgment, award or decree of any court, arbitrator or governmental authority
binding on Client, or any securities issued by Client or of any mortgage,
indenture, lease, contract or other agreement, instrument or undertaking to
which Client is a party or by which Client or any of its assets may be bound,
the violation of which would have a material adverse effect on the business
operations, assets or financial condition of Client and will not result in, or
require, the creation or imposition of any lien on any of its property assets
or revenues pursuant to the provisions of any such mortgage indenture, lease,
contract or other agreement, instrument or undertaking.


Section 7. Fees. Client shall pay Adviser certain fees for the Services, as
set forth in Appendix B attached hereto. Payment of fees for Services
hereunder shall occur within 15 days of Client’s receipt of Adviser’s written
notice to Client of the calculation of a fee, unless Client objects in writing
within such 15-day period. Adviser and Client shall negotiate in good faith to
resolve any disputes concerning fee calculations.



Section 8. Client Credit Information. Client authorizes Adviser, in its
reasonable discretion, at any time and from time to time, to make or obtain
reports concerning Client’s credit standing and business conduct under the Fair
Credit Reporting Act, as amended. Adviser shall notify Client promptly
following the making or obtaining of any such reports. Client may make a
written request for a description of the nature and scope of the reports made
by Adviser and the same will be provided promptly to Client.



Section 9. Valuation. Pursuant to the agreement between Client and the
Custodian of the Account to be agreed upon by Client and the Custodian, the
Custodian on a periodic basis will value securities in the Account after
obtaining pricing information from an independent pricing service, approved by
Client from time to time, which initially shall be Bear Stearns Pricing Direct.




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Section 10. Brokerage and Custody.




     (a) Unless otherwise directed by Client, Adviser is authorized to select
the brokers or dealers that will execute purchase and sale transactions for the
Account. Client will be responsible for paying all brokerage commissions.
Custody of Account assets will be maintained with an independent custodian (the
“Custodian”). Client will be responsible for entering into a custodian
agreement with the Custodian. Adviser shall not have custody of any assets or
funds in the Account. Client will be solely responsible for paying all fees or
charges of the Custodian. Client will provide, or will direct the Custodian to
provide, to Adviser copies of all periodic statements and other reports for the
Account prepared by the Custodian, as well as access to Account data via
electronic interface. Adviser shall direct all brokers or dealers executing
orders on behalf of the Account to forward confirmations of those transactions
promptly to the Custodian.



     (b) Upon the receipt by Adviser of a written request signed by a duly
authorized officer of Client, requesting Adviser to release to Client money or
other property held by Adviser for the account of Client (taking into account
liabilities under repurchase agreements and collateralized obligations of the
Account), if any, Adviser shall promptly, but in no event later than thirty
(30) days after such request, release such money or other property to Client.


Section 11. Confidentiality. Except as otherwise agreed in writing or as
required by law: (a) Adviser will keep confidential and will not disclose any
information it obtains from time to time in connection with Services rendered
under this Agreement and (b) Client will keep confidential and for Client’s
exclusive use and benefit all investment advice furnished by Adviser.



Section 12. Service to Other Clients. Client acknowledges and agrees that
Adviser will perform advisory services for various clients, and may give advice
and take action with respect to any Client which may differ from the advice
given or the timing or nature of action taken with respect to the Account.
Except as required by applicable law, nothing in this Agreement shall limit or
prevent Adviser or any of its officers, affiliates, or employees from buying,
selling or trading in any security for its own account.




Section13. Risk Acknowledgment.



(a) Adviser does not guarantee: (i) the future performance of the Account; (ii)
any specific level of performance; (iii) the success of any investment decision
or strategy that Adviser may use; or (iv) the success of Adviser’s overall
management of the Account. Client understands that the recommendations made
for Client’s Account by Adviser are subject to various market, currency,
economic and business risks as set forth on Appendix C attached hereto,
and that such recommendations will not always be profitable. Adviser will make
recommendations solely with respect to the assets held in
Client’s Account, and in making recommendations for the Account, Adviser will
not consider any other securities, cash or other investments owned by Client.




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(b) Adviser will not be liable to Client for: (i) any loss that Client may
suffer by reason of any recommendation or investment decision made or other
action taken or omitted in good faith by Adviser; (ii) any loss arising from
Adviser’s adherence to Client’s written or verbal instructions; or (iii) any
act or failure to act by the Custodian, any broker or dealer to which
transactions for the Account are directed, except as otherwise provided by law
and in the case of acts or omissions, errors in judgment or mistakes of law by
Adviser constituting bad faith, willful misconduct, gross negligence or
recklessness. The federal securities laws impose liabilities under certain
circumstances on persons who act in good faith, and therefore nothing in this
Agreement shall waive or limit any rights which Client may have under those
laws.



Section 14. Proxy Voting and Other Legal Actions. Adviser will not vote, or
give any advice about how to vote, proxies for securities held in the Account.
Adviser will not advise Client or act for Client in any legal proceedings,
including bankruptcies, involving securities held or previously held by the
Account or the issuers of these securities.




Section 15. Termination.




     (a) This Agreement will continue in effect until one year from the date
hereof (the “Initial Term”) unless earlier terminated as provided below.



     (b) This Agreement may be terminated at any time prior to the conclusion
of the Initial Term:




	 	(i)	 	by Client, if Adviser breaches a material
provision of this Agreement, upon not less than sixty (60)
days prior written notice to Adviser;
	 
	 	(ii)	 	by Client, for any reason, upon not less than
thirty (30) days prior written notice to Adviser, subject to
Client making the payment described in Section 15(c) below;
or
	 
	 	(iii)	 	by Adviser, if Client breaches a material
provision of this Agreement or changes the investment
strategy of the Account from investing in RMBS and fails to
cure such breach to the reasonable satisfaction of Adviser
within thirty (30) days following Client’s receipt of written
notification of such breach.





     (c) In the event Client terminates this Agreement prior to the end of the
Initial Term for any reason other than provided for in Section 15(b)(i) above,
Client shall pay Adviser a termination fee equal to $500,000 per full calendar
quarter (and a pro-rata portion of $500,000 for any period of time less than a
full calendar quarter) of the period remaining from the beginning of the
effective date of termination of this Agreement through September 30, 2005. For
purposes of this Section 15(c) the first calendar quarter shall begin on July
1, 2004.



     (d) In the event this Agreement is not terminated during the Initial Term,
this Agreement shall continue in effect until terminated by either Client or
Adviser upon not



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less than ninety (90) days prior written notice to the other,
provided, however, that no such notice of termination may be given during the
Initial Term.




     (e) Notwithstanding the foregoing, Adviser agrees that, if requested by
Client, Adviser shall continue to provide Services and this Agreement shall not
terminate until the earlier of (i) such time that Client is able to find a
substitute adviser on terms reasonably comparable to the terms hereof or (ii)
ninety (90) days from the date Adviser specified as the termination date in its
written notice to Client.



     (f) Termination of this Agreement will not affect: (i) the validity of any
action previously taken by Adviser or Client under this Agreement; (ii)
liabilities or obligations arising from transactions initiated before
termination of this Agreement; or (iii) the force and effect of Section 7,
Section 10(b), Section 11, Section 12, Section 15, Section 18, Section 19 and
Section 20. Upon the termination of this Agreement, Adviser will not have any
obligation to recommend or take any action with regard to the securities, cash
or other investments in the Account except with respect to transactions
initiated before termination of this Agreement and shall not be entitled to
compensation for Services, except for compensation accruing prior to the date
of termination, which shall be pro rated to the date of termination consistent
with the terms and conditions hereof.



     (g) In the event this Agreement is terminated for any reason, Adviser
shall use its reasonable best efforts to assist in the transition to Client or
its designee of any activities or obligations which were being performed by
Adviser hereunder. Without limiting the generality of the foregoing, Adviser
shall (i) make its personnel and other resources reasonably available to Client
for a reasonable period of time not to exceed sixty (60) days from the date of
notice of termination and (ii) deliver to Client (A) a full accounting of the
Account, including a statement showing all payments collected and all property
held and (B) all property and documents of Client then in the custody of
Adviser.


Section 16. Client Authority. The person signing this Agreement on behalf of
Client represents that he or she has been authorized to do so by appropriate
corporate action. Client shall inform Adviser of any event which might affect
this authority or the propriety of this Agreement.



Section 17. Binding Agreement; Assignment. This Agreement will bind and be for
the benefit of Client and Adviser and their successors and permitted assigns,
except that this Agreement and none of the rights interests or obligations
hereunder may be assigned (within the meaning of the Advisers Act) by
Client or Adviser without the prior written consent of the other party to this
Agreement; provided, however, Client may assign any or all of its
rights, interests and obligations hereunder to a wholly owned subsidiary of
Client without the prior written consent of Adviser.



Section 18. Governing Law and Dispute Resolution. This Agreement will be
governed by and construed in accordance with the laws of the State of Delaware
without giving effect to any conflict or choice of law provisions; provided, however,
that nothing in this Agreement will be construed in any manner inconsistent
with the Advisers Act or any




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rule or order of the SEC under the Advisers Act.
Any controversy or dispute which may arise between the parties hereto
concerning any transaction or the construction, performance or breach of this
Agreement shall be settled by binding arbitration. The award of the
arbitrators shall be final and binding on the parties and judgment upon the
award rendered may be entered into any court having jurisdiction. THE PARTIES
HEREBY WAIVE THE RIGHT TO A TRIAL BY JURY IN ANY SUCH DISPUTE.



Section 19. Notices. Any notice, advice or report to be given pursuant to this
Agreement shall be in writing and shall be deemed to have been duly given, made
and received (a) when delivered by hand, (b) 1 business day after having been
sent by reputable overnight courier service (charges prepaid), (c) 1 business
day after being sent by facsimile transmission or (d) 4 business days after
being mailed by certified or registered mail, return receipt requested and
postage prepaid, in each case at the address set forth below:




If to Adviser:



FBR Investment Management, Inc.

1001 Nineteenth Street North

Arlington, VA 22209

Attn: Neal Wilson

Facsimile: (703) 312-9501



With a copy to:



William Ginivan, Chief Legal Officer

Friedman, Billings, Ramsey Group, Inc.

1001 Nineteenth Street North

Arlington, VA 22209

Facsimile: (703)469-1140



If to Client:



Aether Systems, Inc.

11500 Cronridge Dr., Suite 110

Owings Mills, Maryland 21117

Attn: Chief Financial Officer



Facsimile: (410) 356-8699



With a copy to:



Kirkland & Ellis LLP

655 15th Street, N.W., Suite 1200

Washington, D.C. 20005







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Attn: Mark D. Director, Esq.

Facsimile: (202) 879-5200



Section 20. Miscellaneous. If any provision of this Agreement is or should
become inconsistent with any law or rule of any governmental or regulatory body
having jurisdiction over the subject matter of this Agreement, the provision
will be deemed to be rescinded or modified in accordance with any such law or
rule. All other provisions of this Agreement will continue and remain in full
force and effect. No terms or provision of this Agreement may be waived or
changed unless in a writing signed by the party against whom such waiver or
change is sought to be enforced, except as otherwise permitted by this
Agreement and that Client shall be permitted to change or amend Appendix
A or Appendix D without the prior consent of Adviser, provided that
Adviser receives written notification prior to such change or amendment.
Client’s or Adviser’s failure to insist at any time upon strict compliance with
this Agreement or with any of the terms of the Agreement or any continued
course of such conduct on its part will not constitute or be considered a
waiver by Client or Adviser of any of its rights or privileges. This Agreement
contains the entire agreement and understanding between the parties hereto and
supersedes all prior and contemporaneous agreements and understanding
concerning the subject matter of this Agreement. Client and Adviser are not
partners or joint ventures with each other, and nothing in this Agreement shall
be construed to make them such. The Appendices identified in this Agreement
are incorporated herein by this reference and made a part hereof. This
Agreement may be executed in counterparts, each of which shall be deemed to be
an original as against any party whose signature appears thereon, and all of
which shall constitute one and the same instrument.



Section 21. Disclosure. Part II of Adviser’s Form ADV is attached as
Appendix E.




Signature Page Follows




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     IN WITNESS WHEREOF, the parties hereto have caused this Investment and
Trading Management Agreement to be executed by their duly authorized
representatives as of the day and year first written above.



	 	 	 
	

	 	FBR INVESTMENT MANAGEMENT, INC.
	 
	 	 
	

	 	By: /s/ Richard Hendrix
	

	 	
 
	

	 	Name: Richard Hendrix
	

	 	Title: Co-President and Chief Operating Officer
	 
	 	 
	

	 	AETHER SYSTEMS, INC.
	 
	 	 
	

	 	By: /s/ David S. Oros
	

	 	
 
	

	 	Name: David S. Oros
	

	 	Title: Chairman and CEO

















 






Appendix A




INVESTMENT OBJECTIVE AND FOCUS




Investment Objective



The investment objective of the Account is to seek a high risk-adjusted return
on capital. There can be no assurance that the Account will achieve its
investment objective or not lose money.




Investment Strategy



Adviser will seek to achieve the Account’s investment objective by investing
exclusively in adjustable-rate RMBS issued by Federal Home Loan Mortgage
Corporation (“FHLMC”), the Federal National Mortgage Association
(“FNMA”) or the Government National Mortgage Association
(“GNMA”). The Account will invest primarily in mortgage-backed
securities that have coupon rates which adjust over time (subject to certain
limitations and lag periods) in conjunction with changes in short-term interest
rates. Those adjustments are based on an objective index, such as LIBOR, the
Treasury Index, or the CD Rate. The Account will finance its investment in
RMBS primarily by entering into reverse repurchase agreements that seek to
enhance the overall performance return on capital invested in the portfolio.



Adviser will employ risk management systems to actively monitor and manage the
Account’s exposure to interest and mortgage prepayments rates, the shape of the
yield curve, credit risk, risk of capital loss, the availability and cost of
financing, and changing yield spreads relating to RMBS. In particular, the
investment strategy will emphasize relative value asset selection, as well as
liability structuring and use of hedging instruments, including futures,
options, swaps, caps and floors, to manage the differential risks inherent in
the Account’s investment strategy. Notwithstanding the foregoing, there can be
no assurance that the Account will achieve its investment objective or be
successful in executing its investment strategy.




Mortgage Assets



The Account will invest in RMBS, issued or guaranteed by FHLMC, FNMA and GNMA,
that represent an ownership interest in a pool of mortgage loans (“Mortgage
Certificates”).



Adviser will acquire RMBS that are consistent with the Account’s risk
management parameters and the terms and conditions of this Agreement and that
Adviser believes can be readily financed. Because the Account will generally
hold its RMBS until maturity, the Account generally will not seek to acquire
assets whose investment returns are only attractive in a limited range of
scenarios. The Account may, however, sell RMBS prior to maturity to meet the
Account liquidity needs, and withdrawals may affect the management of the
Account’s portfolio. Adviser believes that future interest rates and mortgage
prepayment rates are very difficult to predict. Therefore, Adviser seeks to




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acquire RMBS for the Account that Adviser believes will provide acceptable
performance returns over a broad range of interest rate and prepayment
scenarios.



The RMBS in which the Account will invest may represent the entire or partial
ownership interest in pools of mortgage loans made by lenders such as savings
and loan institutions, mortgage bankers, and commercial banks. Pools of
mortgage loans are assembled for sale to investors (such as the Account) by
various government, government-related and private organizations. Mortgage
Certificates differ from other forms of traditional debt securities, which
generally provide for periodic payments of interest in fixed amounts with
principal payments at maturity or specified call dates. Instead, Mortgage
Certificates provide for a monthly payment that consists of both interest and
principal. In effect, these payments are a “pass-through” of the monthly
interest and principal payments made by the individual borrowers on their
mortgage loans, net of any fees paid to the issuer or guarantor of such
securities. Additional payments denied from prepayment of principal resulting
from the sale of the underlying property, refinancing or foreclosure, net of
fees or costs that may be incurred. Some Mortgage Certificates, such as
securities issued by GNMA, are described as “modified pass-through.” These
securities entitle the holder to receive all interest and principal payments
owed on the mortgage pool, net of certain fees, regardless of whether or not
the mortgagors actually make mortgage payments when due.



Upon notice from Client that Client intends to rely on section 3(c)(5) of the
1940 Act, Adviser will at all times ensure that the Account holds not less than
55% of its total assets in Qualifying Interests and not less than 25% of its
total assets in Non-qualifying Interests, except that such latter percentage
may be reduced to the extent that the Account’s investments in Qualifying
Interests exceeds 55%. Adviser shall adjust the percentage of assets invested
in Qualifying Interests and Non-qualifying Interests if so directed by Client.



The investment characteristics of pass-through Mortgage Certificates differ
from traditional fixed-rate income securities. The major differences include
payment of interest and principal on the Mortgage Certificates on a more
frequent schedule, as described above, and the possibility that principal may
be prepaid at any time due to prepayments on the underlying mortgage loans or
other assets. These differences can result in significantly greater price and
yield volatility than is the case with traditional fixed-income securities.



The occurrence of mortgage prepayments is affected by factors including the
level of, and changes in, interest rates, general economic conditions, the
location and age of the mortgage and other social and demographic conditions.
Generally, prepayments on pass-through Mortgage Certificates increase during
periods of falling mortgage interest rates and decrease during periods of
rising mortgage interest rates. Reinvestment of RMBS prepayments may occur at
higher or lower interest rates than the original investment, thus affecting the
yield of the Account’s investments. However, in periods of falling rates,
reinvestment will more likely be at a lower rate.




A-2









 








Leverage through Reverse Repurchase Agreements



Reverse repurchase agreements are agreements that provide for the transfer of
securities from a “Seller” to a “Buyer.” Under each reverse repurchase
agreement, the Seller sells securities to the Buyer at an agreed upon price
(the “Initial Purchase Price”). The Buyer simultaneously agrees to
resell the securities back to the Seller (and the Seller agrees to repurchase)
on a future date for a price equal to the Initial Purchase Price plus an amount
representing a specified return (effectively, interest) to the Issuer to cover
interest cost, fees and expenses. Adviser will cause Account to enter into
reverse repurchase agreements only with counterparties with the highest
available long-term debt rating as determined by at least one of the nationally
recognized rating agencies.




Leverage



The Account will finance the acquisition of RMBS by entering into reverse
repurchase agreements. The effect of these agreements is that the invested
capital of the Account will be leveraged. The assets-to-equity ratio of the
Account’s portfolio of RMBS will generally range from 6.0 to 9.0 times,
although the ratio may vary from time-to-time depending upon market conditions
and other factors Adviser deems relevant, including haircut levels required by
lenders and the market value of the RMBS in the Account’s portfolio. For
purposes of calculating this ratio, the Account’s equity is equal to the value
of the Account’s investment portfolio on a mark-to-market basis less the book
value of the Account’s obligations under repurchase agreements and other
collateralized borrowings.



Adviser’s goal is to strike a balance between the under-utilization of
leverage, which reduces potential returns to investors, and the
over-utilization of leverage, which could reduce the Account’s ability to meet
its obligations during adverse market conditions. The Account’s capital
investment policy limits its ability to acquire additional assets during times
when the Account’s assets-to-equity ratio exceeds 9.0. The Account’s capital
base represents the approximate liquidation value of its investments and
approximates the market value of assets that the Account can pledge or sell to
meet over-collateralization levels for its borrowings. The unpledged portion
of the Account’s capital base is available for the Account to pledge or sell as
necessary to maintain over-collateralization for its borrowings.


A-3









 








Appendix B




FEES



A. Management Fee. Adviser shall receive a management fee (the
“Management Fee”) payable quarterly in arrears at a rate
of 0.0375% multiplied by the Aggregate Cost Basis of the
securities in the Account on the last day of each calendar
quarter; for periods of less than one quarter, the amount shall
be pro-rated to reflect the actual number of days the Account was
managed. 



B. Incentive Fee. Adviser shall receive an incentive fee (the
“Incentive Fee”) payable quarterly in arrears. For each
calendar quarter, the Incentive Fee shall be equal to 25% of the
“Incentive Calculation Amount” for the four quarter period ending
with the end of that calendar quarter. For periods in which this
Agreement has been in effect for less than four quarters, the Net
RMBS Income (Loss), reduced by the Management Fee, shall be
annualized for each such period.



The “Incentive Calculation Amount” per quarter is an
amount equal to 10% of the amount by which the Net RMBS Income
(Loss), reduced by the Management Fee for the applicable quarter,
exceeds 10% per annum of the RMBS Equity Account Statement
Balance at the closing of the last day of the preceding quarter.



The “RMBS Equity Account Statement Balance” shall be equal
to the RMBS Equity Account Statement Balance as of the prior
period plus (1) cash contributions made by Client to the Account
during the quarter plus (2) the Net RMBS Income (Loss) (as
defined below) minus (a) cash distributions from the Account
during the quarter (including distributions to Adviser for the
Management Fee). Adviser shall deliver the RMBS Equity Account
Statement Balance within 15 days of the end of each quarter.



“Net RMBS Income (Loss)” shall be the net interest income
or expense of the Account, including income and expenses related
to hedging instruments, realized gains and losses on the sales of
securities in the Account and the amortization of premiums and
discounts on securities in the Account, in each case determined
on an accrual basis and in accordance with generally accepted
accounting principles as in effect from time to time, for and as
of the end of each quarter. Adviser shall deliver the Net RMBS
Income (Loss) Statement within 15 days of the end of each
quarter.



“Aggregate Cost Basis” shall be the price paid for the
securities multiplied by the month end factor.



The following table illustrates the calculation of the Incentive
Fee.


B-1









 







INCENTIVE FEE CALCULATION




	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	 	 	Q1	 	Q2	 	Q3	 	Q4	 	TOTAL
	Book Value of Equity
	 	$	80,000,000	 	 	$	80,000,000	 	 	$	80,000,000	 	 	$	80,000,000	 	 	$	80,000,000	 
	Annual Hurdle (10% ROE)
	 	$	8,000,000	 	 	$	8,000,000	 	 	$	8,000,000	 	 	$	8,000,000	 	 	$	8,000,000	 
	Net MBS Income
	 	$	3,250,000	 	 	$	3,750,000	 	 	$	4,000,000	 	 	$	4,500,000	 	 	$	15,500,000	 
	Annualized ROE
	 	 	16.3	%	 	 	18.8	%	 	 	20.0	%	 	 	22.5	%	 	 	19.4	%
	Annualized or Prior 4 Quarters Net MBS
Income
	 	$	13,000,000	 	 	$	14,000,000	 	 	$	14,666,667	 	 	$	15,500,000	 	 	 	 	 
	Amount in excess of hurdle
	 	$	5,000,000	 	 	$	6,000,000	 	 	$	6,666,667	 	 	$	7,500,000	 	 	$	7,500,000	 
	Incentive Fee (10.0% of annualized excess)
	 	$	500,000	 	 	$	600,000	 	 	$	666,667	 	 	$	750,000	 	 	 	 	 
	Incentive Fee (10.0% of annualized excess for quarter)
	 	$	125,000	 	 	$	150,000	 	 	$	166,667	 	 	$	187,500	 	 	$	629,167	 







	 	 	 	 	 
	ROE Hurdle
	 	 	10.0
	%
	Incentive Fee % of ROE in Excess of Hurdle
	 	 	10.0
	%







B-2










 






Appendix C




RISK FACTORS



An investment in the Account involves a significant degree of risk which
investors should carefully consider. There is no guarantee of successful
performance, that the objective can be reached or that a positive return can be
achieved or losses avoided. As a general rule, investors can expect that
investments with higher return potential will also have higher potential of
risk or loss of capital or income.



Investors in the Account should consider the following risks, which are
intended to be illustrative but not all-inclusive.




INVESTMENT RISKS




Interest Rate Risk



The Account is subject to several risks associated with changes in interest
rates. An increase in the interest payments on the Account’s borrowings
relative to the interest earned on the Account’s RMBS may adversely affect
profitability. The interest payments on the Account’s borrowings may increase
relative to the interest earned on adjustable-rate RMBS.



Differences in timing of interest rate adjustments on the Account’s RMBS and
the Account’s borrowings (through reverse repurchase agreements) may adversely
affect profitability. The Account will rely primarily on short-term borrowings
to acquire RMBS with long-term maturities. Accordingly, if short-term interest
rates increase, this may adversely affect profitability.



Most of the RMBS the Account intends to acquire will be adjustable rate RMBS.
This means that their interest rates may vary over time based upon changes in
an objective index, such as:





	•	 	LIBOR. The interest rate that certain major banks in London offer for
deposits in London of U.S. dollars.
	 
	•	 	Treasury Index. A monthly or weekly average yield of benchmark U.S.
Treasury securities, as published by the Federal Reserve Board.
	 
	•	 	CD Rate. The weekly average of secondary market interest rates on
six-month negotiable certificates of deposit, as published by the
Federal Reserve Board.




These indices generally reflect the impact of a movement in short-term interest
rates. The interest rates on the Account’s borrowings similarly vary with
changes in an objective index. Nevertheless, the interest rates on the
Account’s borrowings will generally adjust more frequently than the interest
rates on the Account’s adjustable-rate RMBS.



All of the Account’s investments are intended to consist of adjustable rate
RMBS. In a period of rising interest rates, interest payments could increase
while the interest earned on fixed-rate




C-1









 







RMBS would not change. This would
adversely affect profitability and the ability of the Account to make
distributions and may result in losses.



The Account’s adjustable rate RMBS are typically subject to periodic and
lifetime interest rate caps. Periodic interest rate caps limit the amount an
interest rate can increase during any given period. Lifetime interest rate
caps limit the amount an interest rate can increase through maturity of an
RMBS. The Account’s borrowings will not be subject to similar restrictions.
Accordingly, in a period of rapidly increasing interest rates, the Account
could experience a decrease in net income or a net loss because the interest
rates on borrowings could increase without limitation while the interest rates
on adjustable-rate RMBS would be limited by caps.




Mortgage-backed Securities



An RMBS is a general obligation of the issuer, which generally is secured by
mortgages or mortgage-backed collateral. RMBS may be issued or guaranteed by
U.S. Government agencies or instrumentalities or by private entities such as
banks, savings and loans, mortgage bankers and other non-governmental issuers.



Faster or slower prepayments than expected on underlying mortgage loans can
dramatically alter the yield to maturity of an RMBS. The value of most RMBS,
like traditional debt securities, tends to vary inversely with changes in
interest rates (i.e., as interest rates increase, the value of such securities
decrease). RMBS, however, may benefit less than traditional debt securities
from declining interest rates because prepayment of mortgages
tends to accelerate during periods of declining interest rates. Prepayments
shorten the life of the security and shorten the time over which the Account
receives income at the higher rate. Additionally, when mortgage loans
underlying RMBS held by the Account are prepaid, the Account then reinvests the
prepaid amounts in other income securities, the yields of which will reflect
interest rates prevailing at the time. Therefore, the Account’s ability to
hold higher-yielding RMBS will be adversely affected by decreasing interest
rates and to the extent that prepayments occur the Account may be forced to
reinvest in securities that have lower yields. Alternatively, during periods
of rising interest rates, RMBS are often more susceptible to extension risk
than traditional debt securities (i.e., rising interest rates could cause
property owners to prepay their mortgages more slowly than expected when the
security was purchased by the Account which may further reduce the market value
of such security and lengthen the duration of the security).



RMBS are not traded on an organized exchange and may, therefore, be difficult
to value.




Decline in Market Value of Mortgage Assets: Margin Calls and Defaults



The Account will pledge its RMBS to secure funding for its investment strategy.
A decline in market value of pledged RMBS may limit the Account’s ability to
borrow or result in lenders initiating margin calls (i.e. requiring pledge of
cash or additional RMBS to re-establish the ratio of amount of borrowing to the
value of the collateral). This remains true despite effective hedging against
such fluctuations as the hedging instruments may not be part of the collateral
securing the collateralized borrowings. The Account may be required to sell
RMBS under adverse market conditions in order to maintain liquidity. Such
sales may be effected by the Account when deemed necessary in order to preserve
the capital base of the Account. If these




C-2









 







sales were made at prices lower than
the amortized cost of the RMBS, the Account would experience losses. A default
by the Account under its collateralized borrowings could also result in a
liquidation of the collateral and a resulting loss of the difference between
the value of the collateral and the amount borrowed.




Reverse Repurchase Agreements



Reverse repurchase agreements involve the risk that the market value of the
securities retained by the Account may decline below the price of the
securities the Account has sold but is obligated to repurchase under the
agreement. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Account’s use of the
proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, of whether to enforce the Account’s
obligation to repurchase the securities. Leverage may increase losses.




Prepayment Rates



The RMBS acquired by the Account are backed by pools of mortgage loans. The
Account receives payments, generally, from the payments that are made on
underlying mortgage loans. When borrowers prepay their mortgage loans at rates
that are faster than expected, the result is prepayments are faster than
expected on the RMBS. These faster-than-expected prepayments on the RMBS may
adversely affect the Account’s profitability.



The Account may purchase RMBS that have a higher interest rate than the market
interest rate at the time. In exchange for this higher interest rate, a
premium over the market value must be paid to acquire the security. In
accordance with accounting rules, this premium is amortized over the term of
the RMBS. If the RMBS is prepaid in whole or in part prior to its maturity date
the premium that was prepaid at the time of the prepayment must be expensed.
This could adversely affect the Account’s profitability.



Prepayment rates generally increase when interest rates fall and decrease when
interest rates rise, but changes in prepayment rates are difficult to predict.
Prepayment rates also may be affected by conditions in the housing and
financial markets, general economic conditions and the relative interest rates
on fixed-rate and adjustable-rate mortgage loans.



Adviser may seek to reduce prepayment risk for the Account by acquiring RMBS at
a discount. If a discounted security is prepaid in whole or in part prior to
its maturity date, the Account will earn income equal to the amount of the
remaining discount. This will improve profitability if the discounted
securities are prepaid faster than expected.



While Adviser seeks to manage prepayment risk to the extent practical, in
selecting investments the prepayment risk must be balanced against other risks
and the potential returns of each investment. No strategy can completely
insulate the Account from prepayment risk.




Financing Terms



Since the Account will rely primarily on short-term borrowings, the ability to
achieve the investment objectives of the Account depends not only on the
ability to obtain money in





C-3










 




sufficient amounts and on favorable terms, but also on the ability to renew or
replace on a continuous basis the maturing short-term borrowings. If the
Account is not able to renew or replace maturing borrowings, it may have to
sell assets under possibly adverse market conditions.



Competition for Assets



The Account’s net income depends, in large part, on its ability to acquire
adjustable RMBS at favorable spreads over its financing costs. In acquiring
RMBS, the Account competes with REITs, investment banking firms, savings and
loan associations, banks, insurance companies, mutual funds, other lenders and
other entities that purchase RMBS, many of which have greater financial
resources than the Account. As a result, the Account may not be able to acquire
sufficient RMBS at favorable spreads over its financing costs.



Investment Portfolio Risks



Investments in securities are by their nature speculative. The value of
securities can be affected by economic conditions, trends in business and
finance, national and world affairs and other events and circumstances
affecting the businesses of the issuers of the securities and the markets for
securities.



There can be no assurance that the Account will be successful or profitable, or
will not suffer losses or that the operations and results of the Account will
be similar to or consistent with the historical operations and results of any
business with which Adviser or its related companies have been associated in
the past. The past performance of entities with which Adviser and its related
companies have been associated is not intended to be, and is not to be
considered as, an indication of the likely future performance of the Account.



Securities markets are by nature volatile, and the value of an investment in
the Account may go down as well as up. Investments of the Account may be
illiquid or difficult to value.



Concentration of Account



Because the Account focuses on a single investment strategy, its performance
depends in large part on the performance of that strategy. As a result, the
value of the Account’s investment may fluctuate more widely than it would in a
fund that is diversified across investment strategies.



Changes in interest rates could negatively affect the value of the Account’s
mortgage loans and RMBS



Under a normal yield curve, an investment in RMBS will decline in value if
long-term interest rates increase. Although Fannie Mae, Freddie Mac, or Ginnie
Mae may guarantee payments on the RMBS the Account owns directly, those
guarantees do not protect the Account from declines in market value caused by
changes in interest rates.



A significant risk associated with a portfolio of RMBS is the risk that both
long-term and short-term interest rates will increase significantly. If
long-term rates were to increase significantly, the market value of its RMBS
would decline and the weighted average life of the investments




C-4









 







would increase. The Account could realize a loss if the securities were sold.
At the same time, an increase in short-term interest rates would increase the
amount of interest owed on its reverse repurchase agreement borrowings.



An increase in the Account’s borrowing costs relative to the interest it
receives on its RMBS may adversely affect its profitability



The Account will earn money based upon the spread between the interest payments
it receives on the RMBS investments and the interest payments it must make on
the borrowings. The Account will rely primarily on short-term borrowings of
funds to acquire mortgage-backed securities with long-term maturities. The
interest the Account pays on its borrowings may increase relative to the
interest it earns on its RMBS. If the interest payments on its borrowings
increase relative to the interest it earns on its RMBS, the Account’s
profitability may be adversely affected.



Prepayment rates could negatively affect the value of the Account’s RMBS



Although Fannie Mae, Freddie Mac or Ginnie Mae may guarantee payments on the
RMBS the Account owns directly, those guarantees do not protect investors
against prepayment risks.



Hedging against interest rate exposure may adversely affect the Account’s
earnings



The Account’s hedging activity will vary in scope based on the level and
volatility of interest rates and principal prepayments, the type of RMBS held,
and other changing market conditions. Interest rate hedging may fail to
protect or adversely affect the Account because, among other things:





	•	 	interest rate hedging can be expensive, particularly during periods
of rising and volatile interest rates;
	 
	•	 	available interest rate hedging may not correspond directly with
the interest rate risk for which protection is sought;
	 
	•	 	the duration of the hedge may not match the duration of the related
liability; and
	 
	•	 	the credit quality of the party owing money on the hedge may be
downgraded to such an extent that it impairs its ability to sell or
assign its side of the hedging transaction.




Hedging and Interest Rate Management



The Account may acquire derivative financial instruments to hedge all or a
portion of the interest rate risk associated with its borrowings. The Account
does not intend to acquire derivative instruments for speculative purposes. The
Account’s hedging activities may include entering into interest rate swaps and
caps, options to purchase swaps and caps, and futures and options on futures.



The Account may engage in a variety of interest rate management techniques that
are intended to match the effective maturity of, and the interest received on,
its assets with the effective maturity of, and the interest owed on, its
liabilities. However, Adviser cannot give any assurances that it


C-5









 






can successfully implement its investment and leverage strategies for the
Account. Adviser’s interest rate management techniques may include:





	•	 	puts and calls on securities or indices of securities;
	 
	•	 	Eurodollar futures contracts and options on such contracts;
	 
	•	 	interest rate swaps, which are the exchange of fixed-rate payments
for floating-rate payments; or
	 
	•	 	other similar transactions.




The Account may also use these techniques in an attempt to protect itself
against declines in the market value of its assets that result from general
trends in debt markets. The inability to match closely the maturities and
interest rates, or the inability to protect adequately against declines in the
market value of its assets, could result in losses with respect to its RMBS.



To limit the adverse effect of rising short-term interest rates under its
short-term repurchase agreements, interest rate management techniques do not
eliminate risk. For example, if both long-term and short-term interest rates
were to increase significantly, it could be expected that:





	•	 	the weighted average life of the RMBS would be extended because
prepayments of the underlying mortgage loans would decrease; and
	 
	•	 	the market value of RMBS would decline as long-term interest rates
increased.




Exchange-Traded Futures Contracts and Options on Futures Contracts



The Account may use financial futures contracts and related options to hedge
against changes in the market value of its portfolio securities or securities
that it intends to purchase. The Account’s use of futures contracts and options
on futures contracts will present the same types of volatility and leverage
risks associated with transactions in derivative instruments generally. In
addition, such transactions present a number of risks which might not be
associated with the purchase and sale of other types of investments.



An interest rate futures contract obligates the seller of the contract to
deliver, and the purchaser to take delivery of, the interest rate securities
called for in the contract at a specified future time and at a specified price.
An option on a financial futures contract gives the purchaser the right to
assume a position in the contract (a long position if the option is a call and
short position if the option is a put) at a specified exercise price at any
time during the period of the option. A single stock futures contract or stock
index futures contract obligates the purchaser and seller to deliver, at a
future date specified in the contract, a cash amount equal to a multiple of the
difference between the value of a single stock or a specified stock index on
that date, and the settlement price specified by the contract.



Prior to exercise or expiration, a futures or option position can be terminated
only by entering into an offsetting transaction. A futures contract sale is
closed out by effecting a futures contract purchase for the same aggregate
amount of securities and the same delivery date. If the sale price




C-6









 







exceeds the offsetting purchase price, the seller immediately would be paid the
difference and would realize a gain. If the offsetting purchase price exceeds
the sale price, the seller immediately would pay the difference and would
realize a loss. Similarly, a futures contract purchase is closed out by
effecting a futures contract sale for the same securities and the same delivery
date. If the offsetting sale price exceeds the purchase price, the purchaser
would realize a gain. If the purchase price exceeds the offsetting sale price,
the purchaser would realize a loss. This risk may be magnified for a single
stock futures transaction, because Adviser must predict the direction of the
price of an individual stock, as opposed to securities prices generally.



The termination of a futures position requires a liquid secondary market on the
exchange on which the original position was established. Adviser intends to
enter into futures and option positions on behalf of the Account only if there
appears to be a liquid secondary market for such instruments, however, there
can be no assurance that such a market will exist for any particular contract
at any point in time. In that event, it might not be possible to establish or
liquidate a position.



The liquidity of a secondary market in futures contracts and options on futures
contracts is also subject to the risk of trading halts, suspensions, exchange
or clearing house equipment failures, government intervention, insolvency of a
brokerage firm, clearing house or exchange or other disruptions of normal
trading activity.



Adviser’s ability to utilize futures or options on futures to hedge the
Account’s exposure to certain positions, or as an alternative to investments in
instruments or markets, will depend on the degree of correlation between the
value of the instrument or market being hedged, or to which exposure is sought,
and the value of the futures or option contract. Because the instrument
underlying a futures contract or option traded by the Account will often be
different from the instrument or market being hedged or to which exposure is
sought, the correlation risk could be significant and could result in
substantial losses to the Account. The use of futures and options involves the
risk that changes in the value of the underlying instrument will not be fully
reflected in the value of the futures contract or option.



Fixed Income Securities



Fixed income securities, including RMBS, are not traded on exchanges. The
over-the-counter market may be illiquid and there may be times when no
counterparty is willing to purchase or sell certain securities. The nature of
the market may make valuations difficult or unreliable.



FHLMC



FHLMC, better known as “Freddie Mac,” is a privately owned government-sponsored
enterprise created pursuant to Title III of the Emergency Home Finance Act of
1970. Freddie Mac’s principal activities currently consist of the purchase of
mortgage loans or participation interests in mortgage loans and the resale of
the loans and participations in the form of guaranteed RMBS. Freddie Mac
guarantees to holders of Freddie Mac certificates, such as the Account, the
timely payment of interest at the applicable pass-through rate and ultimate
collection of all principal on the holder’s pro rata share of the unpaid
principal balance of the underlying mortgage loans, but does not guarantee the
timely payment of scheduled principal on the underlying mortgage loans.




C-7









 







The obligations of Freddie Mac under its guarantees are solely those of Freddie
Mac and are not backed by the full faith and credit of the United States. If
Freddie Mac were unable to satisfy its obligations, the distributions made to
the Account would consist solely of payments and other recoveries on the
underlying mortgage loans, and accordingly, monthly distributions to the
Account would be adversely affected by delinquent payments and defaults on
those mortgage loans. Freddie Mac has a line of credit with the U.S. Treasury,
which has never been drawn upon. FHLMC certificates may pay interest at a
fixed rate or an adjustable rate. The interest rate paid on adjustable-rate
FHLMC certificates (“FHLMC ARMs”) adjusts periodically within 60 days prior to
the month in which the interest rates on the underlying mortgage loans adjust.
The interest rates paid on certificates issued under FHLMC’s standard FHLMC ARM
programs adjust in relation to the Treasury Index. Other specified indices
used in FHLMC ARM programs include the 11th District Cost of Funds Index
published by the Federal Home Loan Bank of San Francisco, LIBOR and other
indices. Interest rates paid on fully indexed FHLMC ARM certificates equal the
applicable index rate plus a specified number of basis points. The majority of
FHLMC ARM certificates issued to date have included pools of mortgage loans
with monthly, semi-annual or annual interest adjustments. Adjustments in the
interest rates paid are generally limited to an annual increase or decrease of
either 100 or 200 basis points and to a lifetime cap of 500 or 600 basis points
over the initial interest rate. Certain FHLMC programs include mortgage loans,
which allow the borrower to convert the adjustable mortgage interest rate to a
fixed rate. Adjustable-rate mortgages which are converted into fixed-rate
mortgage loans are repurchased by the FHLMC or by the seller of the loan to
FHLMC at the unpaid principal balance of the loan plus accrued interest to the
due date of the last adjustable rate interest payment.



FNMA



FNMA, better known as “Fannie Mae,” is a privately owned, federally chartered
corporation organized and existing under the Federal National Mortgage
Association Charter Act. Fannie Mae provides funds to the mortgage market
primarily by purchasing home mortgage loans from local lenders, thereby
replenishing their funds for additional lending. Fannie Mae guarantees to
registered holders of Fannie Mae certificates, such as the Account, that it
will distribute amounts representing scheduled principal and interest (at the
rate provided by the Fannie Mae certificate) on the mortgage loans in the pool
underlying the Fannie Mae certificate, whether or not received, and the full
principal amount of any mortgage loan foreclosed or otherwise finally
liquidated, whether or not the principal amount is actually received. The
obligations of Fannie Mae under its guarantees are solely those of Fannie Mae
and are not backed by the full faith and credit of the United States. If Fannie
Mae were unable to satisfy its obligations, the distributions made to the
Account would consist solely of payments and other recoveries on the underlying
mortgage loans, and accordingly, monthly distributions to the Account would be
adversely affected by delinquent payments and defaults on the mortgage loans.
Fannie Mae has a line of credit with the U.S. Treasury, which has never been
drawn upon. FNMA certificates may pay interest at a fixed rate or an
adjustable rate. Each series of FNMA ARM certificates bears an initial
interest and margin rates tied to an index based on all loans in the related
pool, less a fixed percentage representing servicing compensation and FNMA’s
guarantee fee. The specified index used in different series has included the
Treasury Index, the 11th District Cost of Funds Index published by the Federal
Home Loan Bank of San Francisco, LIBOR and other indices. Interest rates paid
on fully indexed FNMA ARM certificates equal the applicable index rate plus a
specified number of basis points. The majority of series FNMA ARM certificates
issued to date have




C-8









 







evidenced pools of mortgage loans with monthly, semi-annual or annual interest
rate adjustments. Adjustments in the interest rates paid are generally limited
to an annual increase or decrease of either 100 or 200 basis points and to a
lifetime cap of 500 or 600 basis points over the initial interest rate.
Certain FNMA programs include mortgage loans, which allow the borrower to
convert the adjustable mortgage interest rate of the ARM to a fixed rate.
Adjustable-rate mortgages which are converted into fixed-rate mortgage loans
are repurchased by the FNMA or by the seller of the loan to FNMA at the unpaid
principal of the loan plus accrued interest to the due date of the last
adjustable rate interest payment. Adjustments to the interest rates on FNMA
ARM certificates are typically subject to lifetime caps and periodic rate or
payment caps.



GNMA



GNMA, better known as “Ginnie Mae,” is a wholly owned corporate instrumentality
of the United States within the Department of Housing and Urban Development.
Title III of the National Housing Act of 1934 authorizes Ginnie Mae to
guarantee the timely payment of principal and interest on certificates that
represent an interest in a pool of mortgages insured by the Federal Housing
Administration under the Housing Act or partially guaranteed by the Veteran’s
Administration under the Servicemen’s Readjustment Act of 1944 and other loans
eligible for inclusion in mortgage pools underlying Ginnie Mae certificates.
Section 306(g) of the Housing Act provides that “the full faith and credit of
the United States is pledged to the payment of all amounts that may be required
to be paid under any guaranty under this subsection.” An opinion, dated
December 12, 1969, of an Assistant Attorney General of the United States
provides that guarantees under section 306(g) of Ginnie Mae certificates of the
type that the Account may purchase are authorized to be made by Ginnie Mae and
“would constitute general obligations of the United States backed by its full
faith and credit.” The interest rate paid on GNMA certificates may be a fixed
rate or an adjustable rate. The interest rate on GNMA certificates issued
under GNMA’s standard ARM program adjusts annually in relation to the Treasury
Index. Adjustments in the interest rate are generally limited to the annual
increase or decrease of 100 basis points and to a lifetime cap of 500 basis
points over the initial coupon rate.



OTHER RISKS



Past Performance of Adviser



The Account is newly established and has no performance history available to
evaluate its likely future performance. There can be no assurance that the
Account will achieve its investment objective. The past investment performance
of Adviser cannot be construed as an indication of the future results of an
investment in the Account.



The Account’s performance may initially be adversely affected pending the
purchase of securities and the implementation of its investment policies,
particularly in the several-month period following the initial closing, during
which time the Account may not be at its targeted range of leverage.




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Reliance on Management Team



The Account’s success depends on the abilities of the Account’s portfolio
manager and his investment team. If Account’s portfolio manager dies or
becomes incapacitated or for any other reason ceases to act in that capacity,
the Account could be adversely affected. The Account is not the beneficiary of
any insurance on the life of the Account’s portfolio manager. The Account’s
portfolio manager will only devote such time and attention to the Account as he
in his discretion deems necessary or appropriate.



Securities Ratings



Investment grade debt ratings are generally assigned to an obligor whose
capacity to meet its financial commitment on the obligation is extremely
strong. Investment grade debt is said to be of the best quality and considered
to carry the smallest degree of investment risk. Non-investment grade debt
ratings denote speculative investments, which are vulnerable to the nonpayment
of interest and risk the inability to repay principal. Ratings are the opinion
of the agency issuing them, are subject to change, and are not a guarantee of
the ability of the issuer to pay.



Conflicts Of Interests



As a diversified asset management, institutional brokerage, securities research
and investment banking firm, Adviser’s parent company, Friedman, Billings,
Ramsey Group, Inc. (“FBR”) engages in a broad spectrum of activities, including
financial advisory, underwriting and brokerage services. Instances may arise
where the interests of one or more Adviser affiliates, customers or clients,
conflict with the interests of the Account. For example, as of December 31,
2003, FBR manages approximately $10 billion of its own assets in an RMBS
portfolio strategy similar to that proposed for the Account. Adviser, or an
affiliated entity, also may manage RMBS portfolio strategies similar to that
proposed for the Account for other asset management clients. The relationships
among the various Adviser affiliates may also give rise to potential conflicts
of interest.



The Account’s portfolio manager will devote a substantial part of his time to
activities other than those of the Account. The Account’s portfolio manager
may provide financial advice and portfolio management services to clients other
than the Account, some of whose objectives may be similar to that of the
Account. For additional information, see Adviser’s Form ADV, Part II. The
Account hereby acknowledges and agrees that (i) Adviser may buy securities from
and sell securities for the account of other clients of Adviser with an
Adviser affiliate acting as broker; (ii) it agrees that any confirmations,
disclosures or notices required by Rule 206(3)-2 to be given to an advisory
client will be given to the Account’s portfolio manager on behalf of the
Account; and (iii) Adviser and its shareholders, including the principals of
Adviser, may receive an indirect benefit from all fees, commissions and other
benefits received by Adviser from the Account or in connection with the
Account’s transactions.



Adviser and its affiliates may provide investment advice with respect to
securities, may directly or indirectly invest in and dispose of securities for
their own account or for other accounts, in which the Account may from time to
time invest, or in which the Account is able to invest or





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otherwise have any interest, provided that any investments made by Adviser for
its own account in securities in which the Account invests, and which are made
at the same time as the investment of the Account, shall be made on terms and
conditions no better than those received by the Account and only after the
Account has achieved its desired investment position.




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Appendix D




     Adviser must obtain Client’s approval before taking the following actions:




	•	 	Purchasing RMBS individually in an amount exceeding $50 million.
	 
	•	 	Exceeding asset-to-equity ratio of 9:1 or reducing asset-to-equity ratio below 4:1.
	 
	•	 	Purchasing hybrid ARMs greater than 5 years to reset, fixed-rate
RMBS, or RMBS derivatives (e.g., interest-only securities, CMOs with a
weighted-average life of 5 years).
	 
	•	 	Enter into interest rate SWAPS agreements and future contracts.
	 
	•	 	Entering into repurchase agreements with any one counter-party in
an amount that exceeds 35% of outstanding repurchase agreements.





     Adviser must promptly inform Client in writing of the occurrence of any of
the following events:




	•	 	Any material adverse change in credit standing of a repurchase
agreement counterparty, as well as its plan for replacing such
agreements with another counterparty, if necessary.
	 
	•	 	Any material adverse change in collateral terms required by
repurchase agreement counterparties or asset-backed commercial paper.
	 
	•	 	Any material margin calls that a counterparty has requested Adviser
to meet.
	 
	•	 	Any plan to maintain an effective duration between its assets and
liabilities of greater than 2 years, including a rationale for this
recommendation, and a timeframe under which duration will return to
target levels.
	 
	•	 	Any inability to price the RMBS portfolio or significant components
of it for a period exceeding five (5) consecutive trading days or any
inability to obtain month-end or quarter-end prices.
	 
	•	 	Any trades that are not approved on a timely basis.





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Appendix E




     Part II of Adviser’s Form ADV is attached.



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