(HVB Group) Trading The DAX in CDS Format and Playing Equity Versus Debt

Global Markets Research
Euro High Grade
Credit Derivatives Special

February 2005
TRADING THE DAX IN CDS FORMAT ...

Contents … AND PLAYING EQUITY VERSUS DEBT!
CDS quotes for the DAX 30 __2
The basic Merton approach __4 Since the beginning of 2005, we have been providing 5Y CDS quotes for the
The DAX Credit Index swap __9
Fundamental Credit views whole DAX 30 universe. While 23 names out of this universe have been
The eight “exotics” already actively quoted in the CDS market before, there are five names that
Adidas ________________11 have no cash bonds outstanding. Against this backdrop, there are no or only
Altana ________________12
Deutsche Börse ________13 very irregular quotes provided in the CDS market for these names.
Infineon ______________14
Lufthansa _____________15 n Pricing CDS on all DAX names is another step towards a complete market
MAN _________________16 for the 30 biggest public companies in Germany. Besides taking well-
SAP __________________17 diversified equity exposure on the DAX 30 members, an investor is now able to
Schering ______________18
The “High Yields” build up exposure to credit risk on exactly the same underlying assets.
Fresenius _____________19
ThyssenKrupp _________20 n The “unknown variables” in the CDS universe are Adidas, Altana, Infineon,
TUI ___________________21 MAN, Schering and SAP, as these names have no liquid cash bonds
The “usual suspects” outstanding. Despite the fact that hedging is the original motivation of a
Allianz ________________22
BASF __________________22 bondholder for buying protection in the CDS market, pure credit spread trading
Bayer _________________22 is the major incentive for quoting names which have no bonds outstanding.
BMW _________________22
Commerzbank _________22 n How to price an issuer in the CDS market in case there is no outstanding
Continental ____________22
cash bond? There are a couple of names which are actively quoted and traded
DaimlerChrysler ________23
Deutsche Bank _________23 in the CDS market which have no liquid bond outstanding, with Nokia being the
Deutsche Post __________23 most popular. However, according to Bloomberg, Nokia has loans outstanding
Deutsche Telekom ______23
which could be delivered in case of a credit event. In contrast, SAP has no loans
E.ON __________________23
Henkel ________________23 outstanding. Besides the question what happens in case of a credit event, there
HypoVereinsbank ______23 is no cash price which one could use as an orientation level! Against this
Linde _________________24
Metro _________________24
background, we discuss the shortfall of Merton and present our simple rating
Munich Re _____________24 approach.
RWE __________________24
Siemens _______________24 n What happens in case of a credit event for names without deliverable
Volkswagen ___________24 obligations when facing physical delivery as the general CDS standard? We
simply replace “physical” with “cash settlement”, in line within the ISDA
documentation. The definition of a credit event remains unchanged. Besides
Authors restructuring, default and failure to pay are possible triggers (default and failure
Dr. Jochen Felsenheimer
+49 89 378-18188
to pay require the definition of a reference obligation).
Jochen.Felsenheimer@hvb.de
n While all DAX 30 members are now actively priced in the CDS world,
Dr. Philip Gisdakis standardized equity derivatives (options traded on the Eurex platform) are
+49 89 378-13228 highly liquid. This offers the possibility to easily implement capital structure
Philip.Gisdakis@hvb.de
arbitrage trades. That said, investors are able to enter the equity/debt
Michael Zaiser playground, e.g. selling protection on DAX names via CDS, and using the
+49 89 378-13229 protection premium to build up long positions in the equity index.
Michael.Zaiser@hvb.de
n In the aftermath of pricing CDS contracts on every DAX 30 name, it is the
HVB Credit Research Team
next logical step to launch a DAX 30 credit index swap. We highlight how we
derive a fair level of a Credit Index swap and point out quotation biases.
Bloomberg n In the appendix, we include our fundamental credit view for all names
HVCA within the index. We divide the DAX 30 universe into the “usual suspects”
Internet (well-known high-grade names), the “High Yields” (HY and Crossovers) and
www.hvb.de/valuepilot “exotics” (new names in the CDS universe).
© HVB Corporates & Markets, Global Markets Research.

See second to last page for disclaimer.
A member of HVB Group
Euro High Grade
Credit Derivatives Special - Trading the DAX in CDS format ...

February 2005
CDS QUOTES FOR THE DAX 30

THE BASIC IDEA BEHIND
Since January, we have been Since January, our credit trading desk has been actively quoting 5Y CDS for
quoting 5Y CDS for all DAX
members
the whole DAX universe. While 23 names of the DAX index are already liquid
names in the CDS market, there are reference entities which have no liquid
bonds outstanding and hence there is no orientation level for CDS pricing.
Pure credit trading is the While this is rather a theoretical issue, the practical application is obvious: pure
motivation for quoting names
which have no bonds
credit trading! This is exactly what Fitch recently stated in its credit derivatives
outstanding survey. While the major reason for credit derivatives players to participate in
the CDS market is still hedging needs, pure spread trading gained significantly
in importance during the last two years. Against this background, there is a
rising number of market participants who are using CDS as a pure trading
instrument, which is primarily driven by the increased liquidity and
transparency of the CDS market. That said, there are a couple of names which
have no cash bonds outstanding but are very liquid in the CDS universe, e.g.
Nokia. In the following, we discuss topics regarding the technicals (ISDA
conformance, etc.), which are especially of high interest in case of a credit event.
Capital structure arbitrage What is the incentive behind pricing CDS for names which have no bonds
trades
outstanding? Besides the pure trading motivation, the diversification opportunity
for banks, and hedging loan exposure, there are several market participants
who are implementing capital structure arbitrage deals. The idea behind such
deals is based on a simple Merton approach (Merton 1974). In this framework,
an equity investor has a long call option on the company’s assets as he is
participating from the upside potential in case the firm’s value increases. In
contrast, the credit investor is the writer of a put option on the firm assets. He
earns a fixed premium on providing capital, while he has the full downward
risk. This is the case when the firm’s value drops to zero. In these models, there
is consequently a pricing relationship between the company’s stock price and
the pricing of the debt, e.g., reflected in the CDS level.
Positive contagion Given the innovative nature of the credit derivatives market, there is a rising
number of instruments which can be implemented in such trades, e.g. EDS
(Equity Default Swaps). In respect to liquidity, we observe a kind of positive
contagion which is triggered by the development of new products. This means
that introducing innovative instruments leads to increasing investors’ demand
for closely related products. Therefore, pricing the DAX universe in CDS format
is the logical consequence of actively trading credit risk in a capital structure
arbitrage framework.
If you have a strong view on However, besides capital structure arbitrage deals, there is also another field of
the German economy, buy
equities!
application: pricing CDS on all DAX names offers the possibility to actively take
credit exposure in a well-diversified basket including the biggest companies in
Germany (in respect to market capitalization). We will discuss this topic later
when we highlight how to construct a CDS basket based on DAX members. This
is especially an attractive alternative for umbrella funds, which can easily
choose between debt and equity in accordance with their specific view on the
current stage of the business cycle of the German economy. That said, well-
diversified credit risk on an index level is directly comparable to equity exposure
in the DAX universe, even providing an interesting tool on a macro allocation
level. If you have a strong view on the German economy, buy equities. If you are
If you are only moderately
bullish, buy debt!
only moderately bullish, buy debt!
© HVB Corporates & Markets, Global Markets Research. 2

Euro High Grade

February 2005
THE DAX 30 UNIVERSE

DAX 30: Within the DAX 30 index, there are 19 “usual suspects” out of the EUR
- 19 usual suspects
investment grade universe which are already traded in the CDS market. This
- 3 crossover names
- 8 “exotics”
is also true for three names out of the high yield / crossover world, namely
Fresenius, ThyssenKrupp and TUI. Moreover, there are eight “exotics”
(Adidas, Altana, Deutsche Börse, Infineon, Lufthansa, MAN, Schering, SAP),
which have no (liquid) cash bonds outstanding.
In the table below, we list the DAX members including the major equity data,
the rating (in case there is no official rating, we show the HVB shadow rating),
the 5Y CDS level, and whether a reference obligation is available. For our
shadow rating, please refer to the fundamental credit view section.
DAX 30 INDEX – OVERVIEW*
Name Bloomberg Status Share Implied put Rating Shadow- 5Y CDS Reference
CDS Ticker° price vola in % Moody’s/S&P rating HVB bid/offer obligation
ADIDAS CADSG1E5 “exotic” 116.6 16.7 NR A 36/43 No
ALTANA na “exotic” 45.98 17.7 NR A3 17/27 No
ALLIANZ CALZ1E5 liquid 94.15 19.2 Aa3 / AA- 18/20 Bonds
BASF CBASF1E5 liquid 54.02 17.0 Aa3 / AA- 12/14 Bonds
BAYER CBAYR1E5 liquid 25.43 16.5 A3 / A 21/24 Bonds
BMW CBMW1E5 liquid 33.24 16.7 A1 / - 16/19 Bonds
COMMERZBANK CCMZ1E5 liquid 16.92 18.6 A2 / A- 16/18 Bonds
CONTINENTAL CCONT1E5 liquid 57 16.6 Baa2 / BBB+ 29/32 Bonds
DEUTSCHE BOERSE na “exotic” 48 21.9 AA1 / AA+ 2/12 Bonds**
DEUTSCHE BANK CDB1E5 liquid 68.1 17.1 Aa3 / AA- 13/15 Bonds
DAIMLERCHRYSLER CDCX1E5 liquid 36.08 18.5 A3 / BBB 53/56 Bonds
DEUTSCHE POST CDPW1E5 liquid 18.03 14.6 A1 / A 10/17 Bonds
DEUTSCHE TELEKOM CDT1E5 liquid 16.6 16.6 Baa1 / BBB+ 32/34 Bonds
E.ON CEON1E5 liquid 70 12.3 Aa3 / AA- 15/17 Bonds
FRESENIUS MEDICAL CARE CFME1E5 “high yield” 63.05 17.2 Ba1 / BB+ 72/82 Bonds
HENKEL CHENK1E5 liquid 72.6 13.7 A2 / A- 18/21 Bonds
HVB* CHVB1E5 liquid 17.31 24.4 A3 / A- 23/25 Bonds
INFINEON CIFX1E5 “exotic” 7.23 31.4 NR B+ 180/240 No
DEUTSCHE LUFTHANSA CLUFT1E5 “exotic” 11.09 18.3 Baa2 / - 49/54 Bonds
LINDE CLIND1E5 liquid 51.61 16.8 A3 / BBB+ 19/22 Bonds
MAN CMAN1E5 “exotic” 31.74 20.3 NR BBB+ 45/55 Bonds
METRO CMTRO1E5 liquid 40.58 19.3 Baa1 / BBB 43/46 Bonds
MUNICH RE CMURE1E5 liquid 90.18 19.1 Aa3 / A+ 20/22 Bonds
RWE CRWE1E5 liquid 47.36 14.8 A1 / A+ 16/19 Bonds
SAP CSAP1E5 “exotic” 122.9 20.5 NR A 9/19 No
SCHERING na “exotic” 54.75 21.5 A2 / A 16/26 No / Loan
SIEMENS CSIEM1E5 liquid 60.7 16.6 Aa3 / AA- 15/18 Bonds
THYSSENKRUPP CTHYS1E5 “high yield” 16.77 15.4 Baa2 / BB+ 52/55 Bonds
TUI CTUI1E5 “high yield” 18.25 20.3 NR BB+ 150/160 Bonds
VOLKSWAGEN CVW1E5 liquid 37.3 21.5 A3 / A- 48/51 Bonds
DAX 4.362,14 11.51*** - - 36/42 -
* market quotes from February 7, 2005
** bond issued by special purpose vehicle
*** VDAX
° Bloomberg CDS Ticker for 5Y EUR Senior CDS contracts: CBMW1E5 Curncy <Go>
Source: HVB Global Markets Research

Euro High Grade

February 2005
THE ABSENCE OF A REFERENCE OBLIGATION

Physical settlement is the While physical settlement requires the existence of a deliverable obligation,
standard procedure in case of a
credit event …
there are five names which have no (or not enough!) reference bonds or
loans outstanding. However, also cash settlement (which requires no
deliverable obligation) is consistent with to the ISDA documentation.
… but requires the existence of The standard procedure in case of a credit event is physical settlement. The
a deliverable obligation
protection buyer delivers the defaulted asset to the protection seller and gets the
par value in cash within 30 days (settlement period). The physical settlement
amount equals the calculation amount multiplied by the reference price (in
general 100%). The advantage of physical settlement is that there is no need to
determine the market price (recovery) in case of a credit event as the deliverable
obligations are defined ahead (reference obligations).
In case of a credit event, the This works only in case there are bonds (or at least loans) outstanding. If not,
appropriate mechanism is cash
settlement for names which
the appropriate mechanism in case of a credit event is cash settlement. That
have no cash bonds means the protection buyer receives par minus the recovery rate (default price)
outstanding of the reference credit in cash in case of a credit event. The recovery value is the
result of a dealer poll 2-3 weeks after the credit event, delayed for the purpose
that the recovery value can stabilize. The payment amounts to 100% - recovery
value, while liquidity constraints complicate the price determination.
=> no legal or theoretical To sum up, there is no theoretical and legal problem in trading CDS on reference
problem in pricing “no-cash-
outstanding” reference entities
entities which have no cash bonds outstanding. Nevertheless, there might be
technical reasons for a couple of accounts to trade CDS as risk management
systems could not adequately measure risk parameters for CDS on such names
in the absence of reference prices. Therefore, we focus in the following on
alternatives to derive a fair CDS quote for the five “exotics”.
THE BASIC MERTON APPROACH

PRICING DEBT USING INFORMATION FROM EQUITY MARKETS
Structural models have been The name structural models is derived from the fact that balance sheet
introduced by Merton (1974)
information is used to construct a measure of credit risk. These models have
been introduced by Merton (1974), who has extended the pioneering
approach by Black and Scholes (1973).
How can the debt of the firm Although modeling default risk, i.e. defaultable debt, is their main task, they
be linked to its share price?
even aim to answer a more general question: How can the debt of the firm be
linked to its share price? One can distinguish between models where default can
only be triggered at the time of maturity or at coupon dates, from those where
default already occurs when the value of the firm hits a specific (time-
dependent) barrier. Furthermore, new approaches incorporate market risk in
the form of interest rate risk in our model. Finally, there are models with an
endogenous, in contrast to an exogenous, bankruptcy level. Practical
implementations like Moody’s KMV or CSFB’s basic CUSP model are rather
simple as the credit evaluation depends, simply stated, on the absolute level of
equity and on equity volatility.
Shortfall: At the time being, we are rather cautious in respect to basic Merton models as
The “WACC-problem”
we share the view that the “Weighted Average Cost of Capital” has to be
considered. The WACC is calculated as the cost of debt (equals the spread and

Euro High Grade

February 2005
taking the tax rate into account) multiplied by the percentage share of debt plus
the cost of equity (considering beta) multiplied by the percentage share of equity.
The optimal capital structure for a company could then easily be derived by
choosing the lowest point of the WACC curve. From a WACC point of view,
The capital structure might be deleveraging, therefore, has a natural limit. In other words, the capital structure
a financial policy target of a is a financial policy target of a corporation. There is a limitation of deleveraging
corporation
until the point when the utility of further deleveraging (leading to an improving
credit quality and, consequently, lower spread levels) is more than offset by the
rising marginal costs of decreasing the share of debt (due to the reduced tax-
deductibility). In our view, current implied credit quality is near the optimal
point on the WACC curve, which argues for limited incentive to deleverage
further.
INHERENT PROBLEMS WHEN DEALING WITH MERTON MODELS

A Merton approach is a very While a Merton approach is a very elegant solution to price debt using
elegant solution, …
information from equity markets, there are several shortfalls in practice.
There is not one model which generates a stable relationship between debt
and equity of a firm for all companies in the credit universe. While
calibrating Merton-based models to market prices is a tough task given the
fact that there are a couple of non-observable input factors, which have to
be estimated, there is another crucial disadvantage. The assumption that
only markets drive the debt-equity ratio, which is a major factor in the
model, is obviously misleading. If the capital structure is a target of the
financial policy of a company, it is not only asset value and asset volatility
which determines the debt-equity ratio.
… while there are several General findings show that structural models do not accurately measure credit
shortfalls in practice
spreads. Although specific models generate good results for single companies,
the general outcome of using Merton models is that they underestimate spreads
for high volatility companies, while they overestimate spreads for low yield
companies.
MERTON MODELS
Source: Fraunhofer Institut, HVB Global Markets Research

Euro High Grade

February 2005
Model-specific input factors are While the asset value and the outstanding notional debt are input factors for all
the recovery rates, the
volatility of the recovery rate,
models, model-specific input factors are the recovery rates, the volatility of the
jump frequency and jump recovery rate, jump frequency and jump intensity. As a couple of input factors
intensity are not observable in the market, estimations are necessary.
In the following, we use five models (the Merton approach, Credit Grades,
Duffie/Lando, Zhou and Black/Cox) to calculate implied CDS spreads for 16
liquid German names and compare the outcome with market levels.
Merton models underestimate In the table below, we highlight that there is no “key of wisdom-model”. On the
the spread of low vola
companies and vice versa
contrary, an analogy between model spreads and market quotes seems to be
rather accidental. The above-mentioned failure of these models, however, is
affirmed: the spread of low volatility companies is underestimated. This is even
true despite the fact that two times the implied volatility is used as an input
factor, which improved the fit of these models significantly. Although further
modifications (adjusting the equity-debt ratio), can help to improve this result
for specific companies, this does not affect the general outcome of our analysis:
Merton models fail to predict market spreads accurately.
MERTON MODELS: IMPLIED SPREAD LEVELS FAR AWAY FROM MARKET QUOTES*
Merton Credit Duffie/ Zhou Black/Cox Market

Grades Lando
BASF 0 0 0 0 0 13.45
Bayer 34 76 42 51 41 26.57
BMW 1 0 2 3 1 22.65
Continental 33 65 42 42 40 36.79
DCX 19 40 25 30 23 68.13
DT 46 107 54 74 54 37.92
Eon 2 9 3 7 2 18.50
Henkel 11 25 14 24 12 24.12
Linde 18 53 23 35 20 25.87
Lufthansa 246 420 269 220 327 66.54
Metro 54 114 64 72 65 43.96
RWE 62 164 68 121 72 20.65
Siemens 5 17 8 9 6 16.03
Thyssen 14 36 19 23 16 78.85
Tui 277 430 289 268 378 192.57
Volkswagen 133 250 147 158 169 66.93
* data from December 2004. Two times implied option volatility (at the money) is used.
Source: HVB Credit Trading, HVB Global Markets Research
The crucial input factor is the Despite these problems, in our view, there is a model inherent failure of the
equity-debt ratio
Merton approach which makes the model unstable in respect to a crucial factor:
the equity-debt ratio. The change in this ratio clearly affects the outcome of the
model as a lower ratio argues for a wider spread (as the risk of a default
increases) and vice versa. But the model only works if these changes are driven
by markets! In case there is a “force majeure”, a basic mechanism of the model
is canceled. This is exactly the case if the capital structure is a goal of the
financial policy of a company.

Euro High Grade

February 2005
HVB’S RATING APPROACH

Our quotation is also based on As shown above, relying only on a Merton approach might not be adequate
an internal rating approach, …
for all names. Hence, our quotation is also based on an internal rating
approach. Using this approach, we derive an additional “fair-value” range
for the five exotics. In the following, we explain the process of deriving a
rating-based pricing model for names which have no liquid reference
obligation outstanding.
… which adds value in While this approach is based on a couple of soft facts, we think it provides
combination of a Merton
approach
added value in combination with a Merton approach. We are facing exactly the
same problem as debt origination desks do in case a new (not-rated) issuer will
tap debt markets. First of all, a shadow rating has to be assigned, which shows
the appropriate spread range for the issue, also considering the respective
maturity bracket. Then, the sector to which the name is allocated is taken into
account as there is a sector-specific spread component (depending on sector
fundamentals, e.g. earnings volatility, etc.). Last but not least, there might be
issuer-specific characteristics which have an influence on the price. This means
that there is an alpha-term in the pricing equation.
In practice, we implement this In practice, we implement this process straightforward. Our respective sector
process straightforward:
analysts are assigning a shadow rating for non-rated issuers. Our rating
approach is in line with those of both rating agencies Moody’s and S&P, based
1. Assigning a shadow rating on hard facts (balance sheet items) only, while we do not incorporate soft facts
(like management evaluation). Consequently, we have a first indicative spread
level in line with the respective rating class. Then, we assign a sector beta which
we derive from historical spread swings of specific sectors compared to the
overall market spread. For example, low-volatility sectors (utilities) generate in
2. Taking a sector beta into general a beta below 1, while high-volatility sectors generate a beta above 1
account (automobiles). This is exactly what we can observe in the market, with the
spread for a utility trading below the spread of an equally-rated automobile
company. Multiplying the spread based on the rating category with the sector
beta provides us a rather good indication for the appropriate spread level. The
3. Incorporating issuer- last step is an issuer specific spread discount or spread premium, which is
specific characteristics primarily driven by technical aspects, as well as by issuer-specific
characteristics. Technical aspects include demand/supply characteristics, while
issuer-specific topics are related to micro-fundamentals of the company.

Euro High Grade

February 2005
ARBITRAGE BETWEEN EQUITY & DEBT

Investors are able to enter the While all DAX 30 members are now actively priced in the CDS world,
equity/debt playground
standardized equity derivatives (options traded on the Eurex platform) are
highly liquid. This offers the possibility to easily implement capital structure
arbitrage trades. That said, investors are able to enter the equity/debt
playground, e.g. selling protection on DAX names and using the protection
premium to build up long positions in the equity index. Against this
backdrop, a Merton approach for modeling the debt/equity relationship is
crucial. For a modification of a classical Merton approach, please refer to
our Credit Derivatives Special “Merton meets Markowitz in a CAPM
symphony”, to be released later this month.
Implied option volatility goes Despite the shortfalls of basic Merton models (mentioned above), one can define
hand-in-hand with the CDS
spread
a bondholder’s position as a short put position of the company value, while
equity is the corresponding long call. Factoring in key input data like the
debt/equity-ratio, the share price and share price volatility, there is a simple
option-theory based pricing relationship between debt and equity. A very simple
and intuitive explanation is that declining volatility favors the writer of a put
option and vice versa. Hence, volatility should go hand-in-hand with the credit
spread and the CDS spread, respectively. In the charts below, we highlight the
positive correlation between both data series for DT and Allianz.
CDS AND IMPLIED OPTION VOLATILITY FOR DT AND ALLIANZ (SUBS)

140 50 120 60
Allianz 5Y CDS in bp (LS)
DT 5Y CDS in bp (LS) 45
120 Allianz hist. Implied put vola in % (RS)
100 50
DT hist. Implied put vola in % (RS) 40
100 35
80 40
30
80
25 60 30
60
20
40 20
40 15
10
20 10
20
5
0 0 0 0
May-03 Aug-03 Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-03 Aug-03 Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05
Source: Bloomberg, HVB Global Markets Research
Cross asset trades Based on this pricing relationship, several cross-asset trades are attractive:
- trading vola vs. CDS – Trading implied volatilities (extracted from option prices through combined
option strategies) versus CDS.
- balance sheet arbitrage – Balance-sheet arbitrage trades: While the word “arbitrage” is somewhat
misleading, one can exploit under/overvaluations of equity versus debt.
Especially for funds, we see a huge market potential for debt/equity products.
- sell protection, buy the DAX – Overall bullish investors can sell protection via CDS, and invest the received
premium in the stock market. The advantage is that there are no funding
costs for the DAX investment (except for opportunity costs). However, the risk
of such a trade is high as a downward trend in the DAX goes in general hand-
in-hand with a wider CDS premium.
… also on a macro level – Last but not least, all these trades can be transferred on an index level!

Euro High Grade

February 2005
A CREDIT INDEX SWAP FOR THE DAX 30 AS THE NEXT STEP

A DAX 30 credit index swap In the aftermath of offering CDS contracts for each and every DAX 30 name,
would be the next logical step
in the credit derivatives
it will be the next logical step to launch a DAX 30 credit index swap. This
universe evolution is supported by two obvious factors. First, the DAX index is a well-
established major benchmark for the German equity market. As a large
investor base uses DAX futures or certificates to track their equity
performance, it would be self-evident to introduce a comparable product on
the credit side. This would be a milestone towards the completion of capital
markets from a cross-asset perspective. Secondly, the DJ iTraxx universe
made an impact on credit markets, as it provides investment opportunities
in well-diversified credit portfolios on a European level. A DAX 30 credit
index swap would allow focusing on German titles. In the following, we
depict possible construction principles of a DAX 30 credit index swap,
accompanied by pricing consequences resulting from these characteristics.
A term of 5Y seems clear, A term of five years should be standard for DAX 30 credit index swaps, as the
maybe 10Y as well
underlying 5Y CDS contracts offer the highest liquidity in comparison to other
maturities. In the DJ iTraxx universe, 5Y contracts also proved to be the most
liquid ones. However, as the DJ iTraxx universe comprises 10Y contracts as well
(DJ iTraxx Europe Benchmark and Crossover), there might be a market for 10Y
DAX credit index swaps at a later date.
The weighting scheme Another issue is the weighting scheme for the index. In accordance with the DJ
iTraxx Europe Benchmark index, its subindices, and the Crossover Index,
applying equally-weighted names would be a self-evident solution. As a few
names have no outstanding obligations, a weighting scheme that refers to the
market-capitalization of the respective outstanding debt is out of the question.
Anyway, we assume this issue is of minor importance, as the systematic spread
risk of such a product is of major importance, but not the individual default risk.
This fact already proved true within the DJ iTraxx universe, where equally-
weighted baskets enjoy great popularity. Against this background, we assume
that a DAX 30 credit index swap will refer to a basket of equally-weighted
names.
In any case, the investor has to Irrespective of the chosen weighting scheme for the DAX 30 credit index,
cope with a dispersion bias
when pricing a DAX 30 credit
investors have to cope with the so-called dispersion bias in the context of pricing
index swap, ... such a contract. This is due to the fact that one has to apply a weighted average
calculation to the underlying individual spreads, even if the names are equally
represented within the basket. The resulting difference between an unweighted
mean and the correctly calculated weighted average is referred to as the
dispersion bias. It gets its name from the fact that the magnitude of the bias is
primarily determined by the spread dispersion (variance) within the underlying
basket. Based on current spread levels, we expect a dispersion bias of about 0.5
bp for 5Y contracts, which is mainly due to Infineon and TUI, whose spread
levels exceeds the others significantly (please refer to the left chart below). This
means that calculating a simple unweighted average for the basket constituents
... which is quite remarkable and subsequently subtracting 0.5 bp will result in a sound approximation for the
due to the outliers Infineon correct index swap spread level. In case a 10Y contract will be launched, the
and TUI
spread dispersion would be clearly larger due to the fact that spread dispersion
is usually higher on the long end of the credit curve. Please refer to our Credit
Derivatives Special publication “DJ iTraxx – Credit at its best!”, p. 13 for
details concerning the dispersion bias.

Euro High Grade

February 2005
HETEROGENEITY WITHIN THE DAX 30 BASKET RESULTS IN A NOTABLE DISPERSION BIAS*

12 6
10
5
8
frequency
4
6
frequency
TUI Infinion
3
4
2 2
0
1
0 - 10 bp
over 200 bp
10 - 20 bp
20 - 30 bp
30 - 40 bp
40 - 50 bp
50 - 60 bp
60 - 70 bp
70 - 80 bp
80 - 90 bp
90 - 100 bp
100 - 120 bp
120 - 140 bp
140 - 160 bp
160 - 180 bp
180 - 200 bp
0
AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+
* spread levels from February 7, 2004; ratings taken from S&P as far as possible; if not available, then taken from Moody’s, Fitch, and HVB shadow rating
Source: HVB Credit Trading, Rating Agencies, HVB Global Markets Research
A DAX 30 credit basket would The right chart above highlights the heterogeneity of the DAX 30 index with
be a mixture of HG and HY
names
regard to the constituents’ rating categories. It is obvious that such a basket
would be a mixture of high grade and high yield names, which is in contrast to
the structure of the DJ iTraxx universe where both segments are separated from
each other (DJ iTraxx Europe Benchmark vs. DJ iTraxx Europe Crossover).
Only a rollover period of 3 Another issue that merits further discussion refers to the rollover period of a
months avoids a maturity
mismatch
DAX 30 credit index swap contract. As regular CDS contracts roll every three
months due to standard payments dates March 20, June 20, September 20, and
December 20, a simultaneous roll of the index swap is the only possibility to
avoid a maturity mismatch. This concept refers to a situation where actively
quoted CDS contracts refer to maturities that are not in line with the due date of
the credit index swap. In such a case, one has to apply numerical interpolation
procedures in order to generate maturity-adjusted underlying spread levels.
However, there is a tradeoff between avoiding the maturity mismatch and the
costs of a regular rollover. This is why the IIC defined a six-month rollover
period for DJ iTraxx products.
The existence of a quotation The third possible problem that applies to DJ iTraxx index swaps is called the
bias depends on the
application of an upfront
quotation bias, which is attributable to the fact that the strike spread of DJ
payment iTraxx swaps remains unchanged irrespective of when entering into a contract.
The intrinsic value of such an index swap is initially compensated for by means
of an upfront payment. However, if the DAX 30 index swap is set up in a way
that the quoted spread applies as the contract spread, investors are untroubled
by this issue. Please refer to our Credit Derivatives Special “DJ iTraxx: Credit at
its best!”, p. 21, where we show how to calculate the quotation bias in case it
applies.
Participating in the rollover Last but not least, the composition of the DAX 30 index may change over time.
procedure prevents possible
basket obsolescence
As an already concluded contract cannot be changed with respect to the
structure of the underlying basket, future series account for possible new
constituents. As long as investors make use of the rollover procedure, they will
avoid obsolescence of the basket.

Euro High Grade

February 2005
FUNDAMENTAL CREDIT VIEWS – THE EIGHT “EXOTICS”*
ADIDAS-SALOMON AG (N.R.); HVB CREDIT RESEARCH RATING: A

Bond-Ticker: ADSGR
Recommendation: Buy Analyst: Carmen Hummel
Business Profile: Adidas-Salomon AG, based in Herzogenaurach, Germany, manufactures
sports footwear and sports equipment. The company produces footwear,
Key Indicators FY 2003
sports apparel, skis and snowboards, skateboards, golf clubs and balls,
Sales: EUR 6.2 bn
EBITDA EUR 628 mn climbing equipment, and bicycle wheels. Adidas sells its products worldwide.
Net Debt: EUR 946 mn Its share of the world market for sporting goods is estimated at around 15%.
FFO / Net Debt: 52.1% Adidas-Salomon generates 53.6% of total sales in Europe, 24.9% in North
Net Debt / EBITDA: 1.5x America, 17.8% in Asia and the remaining 3.7% in Latin America.
EBITDA / net interest: 10.6x
According to the published preliminary FY 2004 figures, overall sales increased
3.4% to EUR 6.5 bn. HVB Equity Research estimates FY 2004 EBITDA to total
EUR 730 mn, representing a 16.2% increase versus FY 2003. For FY 2005, the
development is expected to remain as dynamic, with sales increasing 6.9% to
EUR 6.9 bn and with an EBITDA improvement of 14.4% to EUR 835 mn. The
company has a strong focus on de-leveraging and has an excellent debt-
reduction track record (net debt at FYE 2000 EUR 1.8 bn vs. EUR 913 mn for
9M 2004). Going forward, we expect this trend to continue, which also implies a
steady improvement in Adidas’ credit metrics.
– Adidas is one of the strongest global brands
Strengths and Opportunities:
– Leading market positions
– Sound business profile, excellent management
– Strong geographical diversification (see geographical revenue breakdown in
the first paragraph), making it less vulnerable to the weak European macro
environment.
– Sound financial profile, with steadily improving credit profile
Weaknesses and Threats: – Weak consumer sentiment
– Intense competition
– Fashion risk
– Strong dependence on Adidas brand
– Possible debt-financed acquisitions would put pressure on Adidas’ credit
profile in the absence of asset disposals.
Outlook statement: Adidas’ credit metrics improved significantly since FY 2000. With management’s
continued focus on debt reduction and on better profitability, its already sound
credit profile should improve further.
Source: Company reports, HVB Global Markets Research
* We name these issuers “exotic”, although some of them have a cash bond outstanding. Deutsche
Börse AG issued a liquid bond through a Special Purpose Vehicle (DBFIN) and MAN issued a EUR 300
mn bond, which is, however, rather illiquid.

Euro High Grade

February 2005
ALTANA AG (N.R.); HVB CREDIT RESEARCH RATING: A3

Equity-Ticker: ALT
Recommendation: Neutral Analyst: Jochen Schlachter
Business Profile: Altana, based in Bad Homburg, is an international chemicals and
pharmaceutical company. With annual sales of EUR 2.7 bn in 2003, the
research-driven company dwarfs its international peers both in terms of
Key Indicators FY 2003 overall size as well as portfolio diversification. The company’s activities are
Sales: EUR 2.7 bn grouped under the divisions Altana Pharma and Altana Chemie. In its R&D
Net cash: EUR 467 mn intensive Pharma division, Altana focuses on gastrointestinal, respiratory
FFO / Net Debt: n.m. and cancer treatments. The product range of the chemicals division includes
Total Debt / EBITDA: 0.1x
additives, specialty coatings, sealing and casting compounds, electrical
insulation material, impregnating agents as well as testing and
measurements instruments. Altana generates 51% of its sales in Europe,
31% in the lucrative North American markets and the remainder in the rest
of the world.
Strengths and Opportunities: – Near-to-medium term growth potential from pipeline releases in Pharma,
especially Alvesco and Daxas, both potential blockbuster candidates
– Currently favorable market environment in Chemicals
– Strong free cash flow generation with no near-term patent expiration
– Very solid balance sheet profile with net cash position
Experienced management team and shareholder support (Quandt family)
Weaknesses and Threats – Potential margin dilution from weaker Chemicals business in the long term. In
the short term, however, good operating performance in Chemicals should
mitigate pricing pressure in Pharma
– Significant product concentration with top selling Pantoprazole/Protonix
accounting for approx. 40% of group sales and 70% to operating profit (HVB
Equity Research estimate)
– Pricing pressure on Protonix after generic PPI (Prilosec) became available
– Further delays in the approval of Alvesco (mainly in the US) and Daxas could
impact growth prospects and profitability
– Share buy back activity underpins shareholder-friendly posture
Outlook statement: We expect Altana’s credit profile to remain very solid with limited amounts of
balance sheet debt. Free cash flow generation will be insured by continuously
high sales contributions from Protonix, Altana’s main growth driver. Over the
medium term, we also expect contributions from the new asthma treatment
Alvesco, a potential blockbuster drug, which is expected to be launched in the
US market in the near term. However, during the launch phase, Alvesco’s
contributions to bottom line will remain limited, given anticipated marketing
expenses. Hence, excessive and undue pressure on Protonix’ operating
profitability in combination with a delay of the launch of Alvesco may be triggers
for a change in our assessment. Our rating assessment does not factor in major
acquisitions. Nevertheless, smaller bolt-on acquisitions in Chemicals are likely,
as the company wants to establish its footprint in niche markets.

Euro High Grade

February 2005
DEUTSCHE BÖRSE AG (AA1/P-1 STABLE; AA+/A-1 STABLE)

Bond-Ticker: DEUTBO / DBFIN
Recommendation: Neutral Analyst: Luis Maglanoc
Business Profile: Deutsche Börse AG’s (DEUTBO) product and services portfolio covers the
entire process chain from securities and derivatives trading through the
settlement of transactions and provisions of market information right up to
the development and operation of electronic trading systems. In FY 2003,
the group generated revenues and net profit of EUR 1,419.4 mn and EUR
246.3 mn, respectively.
Strengths and Opportunities: The ratings on Germany-based DEUTBO are based on the institution's
– strong position in the European capital markets,
– its low-risk profile, strict risk-management oversight and protective margin
collateral systems, and
– good financial profile.
– DEUTBO has become a critical component of the European capital market,
through investment in technology and the successful execution of a well-
thought out expansion strategy.
Weaknesses and Threats: – A point of uncertainty is the fast-moving environment in which the company
operates. Rapid consolidation or regulatory changes could significantly
change the relative commercial position of the key players of the securities
exchange, clearing, and settlement sector in a short period of time.
Outlook statement: DEUTBO has offered approximately GBP 1.3 bn (~EUR 1.9 bn) all-cash to take
over the London Stock Exchange (23.3% higher that the share-price last
10.12.04 and 52.3% over 22.10.04)
Despite risk associated with the possible take over, this is still considered
positive because of
(a) cost-synergies of EUR 80-100 mn per year, and further savings are possible
from funneling LSE settlement flow through Clearstream;
(b) unrivalled position of merged entity in Europe;
In addition, by year-end 2004, DEUTBO is expected to have cash and other
liquid assets of over EUR 1.3 bn, and on its own (w/o merger) this is expected to
rise to EUR 1.5 bn by end 2005, and EUR 1.7 bn by end 2006
Overall, we have a stable outlook on DEUTBO AG, but depending on the amount
of extra funds it borrows to finance the acquisition, in a worst case, a one-notch
downgrade is possible.
* We assign Deutsche Börse to the “exotics” although the name is already actively traded in CDS
format

Euro High Grade

February 2005
INFINEON TECHNOLOGIES AG (N.R.); HVB CREDIT RESEARCH RATING: B+

Bond-Ticker: IFX
Recommendation: Neutral Analyst: Stephan Haber
Key Indicators FY 2003/04 Infineon Technologies was founded in April 1999, when the semiconductor
(ended 09/2004)
operations of parent company, Siemens AG, were spun off to form a separate
Sales: EUR 7,195 mn
EBITDA: EUR 1,633 mn
legal entity. Infineon Technologies AG offers semiconductor and system
EBITDA margin: 22.7% solutions for the automotive industry and industrial electronics, for
EBIT: EUR 256 mn applications in the wired communications markets, secure mobile solutions
Total debt: EUR 1,998 mn as well as memory products. The company enjoys a global presence in
Net cash: EUR 548 mn
Europe, North America and Asia. In FY 2003/04, with 35,600 employees
Operating CF: EUR 1,857 mn
Free Cash Flow: EUR 206 mn
Infineon generated revenues of EUR 7,195 mn and EBIT of EUR 256 mn,
according to the company.
Strengths and Opportunities: – Good market position in the global DRAM sector: With a market share of 15%
Infineon is the fourth largest supplier of dynamic random access memories
(DRAMs) worldwide after Samsung (27%), Micron Technologies (18%) and
Hynix Semiconductor Inc. (17%). In addition, Infineon had global market
shares of 41% (Source: Gartner 2004) and 8.7% (Source: Strategy Analytics) in
the chip card IC market and in the automotive semiconductor sector.
– The Bit shipment share of non-computing applications increased to more than
30% in Q4 FY 2003/04
– Moderate financial policy: Infineon is moderately leveraged and maintains
high cash balances
The company has good customer relationships and a strong technology base
Weaknesses and Threats: – Infineon’s business profile entails a high degree of business risk because of its
manufacturing intensity, high technology risk, high reliance on commodity
products and a high degree of revenue and earnings volatility stemming from
a cyclical industry.
– Very high technological risk driven by rapid technology evolution and short
product life cycles as well as changing needs of a limited customer base. A
condition to stay in the business is high R&D expenditures (17-18% of sales)
– Very manufacturing-intensive businessèasset-intensive business
(turnover/PPE-ratio 2.0x in FY 2003/2004)ècapital-intensive business
– Relatively low average profitability (average EBIT margin over the last three
years –6.9%) driven by aggressive price pressure and competition in the
industry
– Relatively low average free cash flow generation (average FCF over the last
four years -EUR 550 mn p.a.) driven by high capex needs of the industry (EUR
1.2 bn in FY 2003/2004; target for FY 2004/2005 EUR 1.0 – 1.5 bn).
Outlook statement: – Our outlook for the company is stable. Currently, the company expects a
slowdown in several application segments due to higher inventory levels
compared to previous quarters. According to our equity research colleagues,
one of the main challenges for Infineon is currently the low utilization rate in
its logic (non-DRAM) fabs, which is negatively impacting margins. In addition,
the expected seasonal DRAM demand decline should lead to a related price
decline.

Euro High Grade

February 2005
DEUTSCHE LUFTHANSA AG (BAA2S/BBBS/-)*

Bond-Ticker: LUFTHA
Recommendation: Neutral
Business Profile: Deutsche Lufthansa AG is an aviation group which provides services to the
airline industry. Over the past few years, Lufthansa broadened the scope of
the group, with the objective of withstanding crises and increasing its
Key Indicators FY 2003:
Sales: EUR 15,957 mn flexibility. Lufthansa Passage Airline is the largest operating company in the
Net Debt rep.: EUR 1,387 mn group, accounting for 61% of revenues in 2003. Until the merger of Air
Net Debt & Debt like liabilities: France and KLM in May 2004, it ranked number one worldwide in terms of
EUR 7,850 mn
international passengers carried. Further important business segments are
FFO / Net Debt & Debt like
liabilities:: 23.3% catering (Sky Chefs; 14% of revenues), logistics (Lufthansa Cargo; 13%) and
EBITDA / Net fixed charge cov: maintenance repair overhaul (Lufthansa Technik; 10%). Since 1998
3.2x Lufthansa has a 50% stake in Thomas Cook AG, an international leisure
(Source: S&P Credit Stats)
group. However, the catering and leisure businesses have experienced
significant difficulties and weakened performance. Recently, Lufthansa’s
management stated that its strategy would now be to focus on its core
competencies in its business units as a focused aviation group.
Strengths and Opportunities: – One of the leading European airlines with a well-established position in the
European market, and worldwide Member of Star Alliance
– Strong brand recognition
– Good liquidity position/headroom under available credit facilities
– Significant financial flexibility due to unencumbered asset base
Weaknesses and Threats: – Fragile airline industry due to recent increase in fuel costs, a relatively weak
global economy, especially in Europe (i.e. Germany).
– High competition in the European and the domestic market, particularly on
short-haul routes, with further pressure on yields due to overcapacity and the
expansion of low-cost carriers
– Weaknesses of some of the Star Alliances partners (United Airlines, Air
Canada, SAS)
– Poor performance at Thomas Cook AG and airline catering business, Sky
Chefs
Rating outlook statements: Moody’s (06/07/2004): “The outlook for the rating is stable, reflecting
Lufthansa's high quality and experienced management team, its financial
prudence (as evidenced inter alia in its solid liquidity position) and the
expectation of a gradual recovery in travel volumes.”
S&P (21/12/2004): “The stable outlook reflects S&P's view that demand and
load factors have stabilized in the airline industry and are starting to recover.
S&P’s expects the group to maintain FFO to net debt and pension liabilities of
30% and net debt and pension liabilities to capital of 65%. High fuel prices
remain the greatest threat to improving the group’s profitability and achieving
its targeted operating profit of EUR 300 mn in 2004. Fuel surcharges and
hedging programs will only partially mitigate increased fuel costs. The group’s
latest cost saving program aims to save EUR 1.2 bn over the next three years
and will be crucial for further mitigating expected fuel price increases.”
Source: Moody’s, S&P
* We assign Lufthansa to the “exotics” although the name is already actively traded in CDS format

Euro High Grade

February 2005
MAN AG (N.R.); HVB CREDIT RESEARCH RATING: BBB+

Bond-Ticker: MANAG
Recommendation: Neutral Analyst: Dr. Sven Kreitmair
Business Profile: The Munich-based MAN Group is one of Europe’s leading engineering and
vehicle manufacturing companies. As a worldwide supplier of system
products and services for the capital goods industry, MAN operates in the
core areas of Commercial Vehicles, Industrial Services, Printing Machines,
Key Indicators FY 2003 (incl. Diesel Engines and several specialized sectors of the Industrial Equipment
financial services) and Facilities market. It additionally provides Financial Services on a Group-
Sales: EUR 13.5 bn
wide scale. MAN Group holds between No.1 and No.3 positions in its relevant
Net Debt: EUR 439 mn
FFO / Net Debt: 32.0%
European or world markets in 95% of its OEM sales in 2002. The Group
Net Debt / EBITDA: 2.2x concentrates on three core areas with high-growth potential, which are
motion and transport, communication and media and industrial services. At
the end of Sept. 2004, MAN Group had 61,949 employees worldwide.
Strengths and Opportunities: – No. 1 to No. 3 positions in 95% of its portfolio. In the Western European
heavy (>16 t) and medium (6-16 t) truck markets it is No. 2 by brand and No.
3, respectively. In the Western European market for busses and coaches, it is
No. 3. MAN Roland is No. 1 and 2 in web-fed printing and sheet-fed printing
machines, respectively. MAN B&W Diesel is global market leader in 2-stroke-
diesel engines and No. 2 in 4-stroke-diesel propulsion engines.
– Concentrates on core areas with high mid-to-long term-growth perspectives
Motion and Transport, Communication and Media and Industrial Services.
– Fairly good diversity across business sectors and geographical coverage,
although 41% of sales are derived from the commercial vehicles division and
around 64% of group sales coming from Europe. However, 90% of revenues in
the most important commercial vehicles division are generated in Europe.
– Moderate financial policy, although debt leverage was more conservative
before FY 2001. Since its last major acquisition, Neoplan, however, MAN’s
debt leverage was relatively stable.
Weaknesses and Threats: – MAN operates in capital-intensive, heavy industrial sectors, which are - to a
large part - subject to rather similar economic cycles and are highly
competitive, with constant price and cost pressure from customers and
suppliers. Long-term contracts and the trend for outsourcing and
maintenance of industrial facilities as well as its financial services unit help
the Group to add some stability to the otherwise cyclical business portfolio.
– MAN Group’s overall profitability is relatively weak with an adjusted EBIT-
margin of around 3-5% and adjusted EBITDA margin between 5-10%. The
margins are cyclical in the context of economic conditions and fell to 2.5% in
FY 2002.
– Possible debt-financed acquisitions would put pressure on MAN’s credit
profile in the absence of asset disposals.
Outlook statement: MAN’s credit metrics (both excl. and incl. financial services) improved
significantly since FY 2001. We think that the rating outlook is stable given the
company’s current debtholder-friendly financial policy, positive momentum from
the truck cycle, the strong orderbook and incoming new orders.

Euro High Grade

February 2005
SAP AG (N.R.); HVB CREDIT RESEARCH RATING: A

Bond-Ticker: SAPAG
Recommendation: Buy Analyst: Stephan Haber
Key Indicators FY 2003 SAP AG (SAP) is the global leader in business software solutions. Around
Sales: EUR 7,025 mn 23,400 companies use SAP’s business software worldwide which is the
EBITDA: EUR 1,940 mn
largest installed base in the enterprise software sector. SAP offers strategic
EBITDA margin: 27.6%
Operating income: vertical solutions for more than 25 industries. SAP had a CAGR in total
EUR 1,724 mn revenues and operating income over the last 10 years of 29% and 31%,
Total debt: EUR 22 mn respectively. In 2003, with 29,610 employees SAP generated revenues of
Net cash: EUR 2,075 mn EUR 7,025 mn and pro forma operating income of EUR 1,886 mn, according
Operating CF: EUR 1,505 mn
to the company.
Equity ratio: 59.5%
Strengths and Opportunities: – SAP has a leading market position based on product revenues in the global
application software market with 18%, followed by PeopleSoft (including
JDEC) with 8%, Oracle with 5%, Siebel with 4% and Microsoft with 2%
– Strong brand name recognition: According to Business Week, SAP ranks no.
34 among the top 100 brands globally
– SAP has superior R&D capabilities: R&D expenses amounted to 14.1% of
revenues in FY 2003
– Large installed software and technology base
Strong financial profile based on high free cash flow generation and a solid
balance sheet
Weaknesses and Threats: – Fast moving technology challenges and continued investment in emerging
technologies.
– According to our equity research, the global software sector is not only
proceeding with horizontal consolidation but is also on the threshold of a
cross-sector or vertical consolidation. The biggest providers (e.g. Microsoft,
IBM, Oracle) will increasingly expand their product portfolio vertically. The
upshot of this scenario is that over the medium term the entire software stack
will probably be dominated by a small number of integrated providers, who
will address an even greater portion of IT budgets. Cross-segment
consolidation will drive a large number of specialized “one layer” providers
out of the market, according to our equity research.* While SAP has a strong
market position in the application software segment, it is currently developing
its market position in the business intelligence and middleware software
markets where it does not belong to the top 3 market leaders.
– M&A risk: Even though there is frequent speculation in the market about
major acquisitions by SAP’s, we believe that this is improbable. In line with
the SAP strategy, we expect smaller technology-driven acquisitions to round
out the portfolio.
– Potentially more aggressive shareholder remuneration measures.
Outlook statement – We think that the rating outlook for SAP is stable, given the strong financial
profile and the above average business profile of the company, which is based
on a large installed software base. In our opinion, the main uncertainty
regarding SAP’s rating outlook depends on potential M&A activities of the
company.
*HVB Equity Research: SAP AG company analysis, dated 10/04/2004

Euro High Grade

February 2005
SCHERING AG (A2 STABLE, A STABLE)

Bond-Ticker: SCHGR
Recommendation: Neutral Analyst: Jochen Schlachter
Business Profile: Germany-based Schering is a research-based pharmaceutical company,
focusing on four business areas: Gynecology & Andrology (34% of sales in FY
2003), Specialized Therapeutics (32%), Diagnostics & Radiopharmaceuticals
Sales: EUR 4.8 bn (27%) and Dermatology (4%). Schering is a medium-sized player in the
EBITDA EUR 1.0 bn global pharmaceutical market, but successfully positioned in various niche
Net Cash: EUR -462 markets such as in the global fertility market where it is number 2
mn
worldwide. The group generated in FY 2003 sales of EUR 4.8 bn and an
FFO/Net Debt*: 165.7%
Net Debt*/EBITDA: 0.1x
EBITDA of EUR 1.0 bn. It operates worldwide, with Europe accounting for
EBITDA / net interest: 46x the majority of sales with 49%, followed by the US (25%) and Japan (11%).
*pension-adjusted
Strengths and Opportunities: – Good market position in niche markets such as fertility control, multiple
sclerosis, hematology and in-vivo diagnostics
– Balanced product portfolio
– Positive outlook for the pharmaceutical industry with aging population and
increasing health consciousness
– Strong financial profile reflected in strong credit metrics as FFO to net debt at
165.7% and net debt to EBITDA at 0.1x
– Excellent financial liquidity
– Conservative financial policy
Weaknesses and Threats: – Small size of the company compared to its peers in a market where critical
mass is important to finance R&D spending
– Limited presence in the high margin US prescription drug market
– Lack of a product portfolio comprising blockbuster drugs (drug with sales in
excess of USD 1 bn p.a.)
– Lower profitability compared to the company’s peers due to the limited
presence in the US and the missing blockbuster drugs
– Competitive markets for Schering’s biggest-selling drug Betaferon as well as
for the largest product in the diagnostics division Magnevist
Outlook statement: – In view of a consolidating industry, acquisition activity seems likely, which
should, however, not significantly impact the company’s current strong credit
profile given its good financial flexibility and conservative financial policy. The
group’s strong late-stage product development pipeline (comprising about 11
products) should ensure a stable sales and cash flow generation in the
medium term, even if a large portion of existing products face patent
expiration.
Source: Company reports, S&P, Moody’s; HVB Global Market Research

Euro High Grade

February 2005
FUNDAMENTAL CREDIT VIEWS – THE “HIGH YIELDS*”

FRESENIUS (BA1/BB+/--)
Bond-Ticker: FME
Recommendation: Buy Analyst: Jochen Schlachter
Business Profile: Fresenius is one of the world's leaders in providing products and services for
dialysis, hospital markets and medical care for patients at home. The
company follows an integrated approach through its subsidiaries Fresenius
(estimates): Medical Care (FMC), Fresenius Kabi and Fresenius ProServe. FMC is the
Sales: EUR 7.3 bn world's largest provider of dialysis products and services and the largest
EBITDA EUR 1.1 bn revenue and earnings source for Fresenius. Fresenius holds 50.8% of voting
Net debt EUR 2.8 mn
shares, constituting 36.9% of FMC's issued share capital, while Fresenius
FFO/Net Debt*: 19.4%
Net Debt*/EBITDA: 3.1x
ProServe and Fresenius Kabi are wholly-owned subsidiaries. Fresenius Kabi
EBITDA / net interest: 4.9x is Europe's leading provider of infusion and nutrition therapies. Fresenius
*pension-adjusted ProServe manages healthcare facilities, especially in Germany.
Fresenius primarily viewed as While Fresenius continues to be viewed as a leading dialysis company by the
dialyzes company…
market, we recently observed moves to further cement and expand its position
as Europe’s leading nutrition and infusion therapy through Fresenius Kabi. We
view this as a logical step, as the largely consolidated US hospital market offers
little external growth opportunities going forward. We believe that a
considerable part of its investment and acquisition budget, recently indicated to
… but importance of nutrition
be in excess of EUR 120 mn for 2005, will be directed towards growth in this
and infusion therapy business
growing field, notwithstanding Fresenius’ ongoing commitment to further look for
acquisition opportunities in renal care. Over the long term, we believe that
Fresenius Kabi’s position within the group will be significantly strengthened and
its share of total sales will slowly grow.
ProServe has little bearing on Fresenius ProServe hospital management is relatively small and of low
overall credit profile in our
view
importance to the overall credit profile of the group. While we believe that
operating issues are being addressed by management, we see little contributions
to earnings and cash flows from the segment in the near term. Partnering the
business in the consolidating German private hospital market may be a strategic
solution. We also see some risk of strategic acquisitions in this sector.
We see little chance for a near- We believe Fresenius’ chances for a near-term upgrade are fading away,
term upgrade
following the subpoena in the US and given its significant leverage. While the
recent change in reimbursement practices is expected to be credit neutral, we
note that it is only temporary and thus uncertainties continue to exist. The
recent refinancing at FMC should lower Fresenius’ interest burden, thus freeing
up cash that can be used for debt reduction and further growth. Nevertheless,
positive rating pressure may result from continued debt reduction and
improving operating profitability, which may lead to an outlook change,
probably early as late 2005. However, the time horizon for an upgrade has been
pushed out well into 2006, in our view.
Low risk for a high yield Main risks with respect to Fresenius remain large scale strategic acquisitions, a
company
more shareholder-oriented policy, potential litigation and currency fluctuations,
while we believe operating business risk remains comparatively small. Stable,
non-cyclical cash flow generation resulting from favorable demographics and
considerable expertise in renal therapy make Fresenius an attractive credit in
our opinion.
* For a more detailed analysis regarding our High Yield coverage, please refer to our quarterly High Yield flagship
publication: “Euro High Yield & Crossovers” (Last edition: “Steady as she goes” from December 2004)

Euro High Grade

February 2005
THYSSENKRUPP (BAA2S/BB+WP/BBBWP)
Bond-Ticker: TKAGR
Recommendation: Hold Analyst: Jana Arndt
Business Profile: Germany based ThyssenKrupp is a large industrial conglomerate,
generating sales of EUR 39.3 bn in FY 2003/2004 in the steel, capital goods
and services businesses. The company’s activities are organized in five
Key Indicators FY 2003/2004
Sales: EUR 39.3 bn segments: steel (34.9%), automotive (18.6%), elevator (9.1%), technologies
EBITDA*. EUR 3.9 bn (12.9%) and services (30.3%). The steel segment belongs to the world’s
Net Debt*.: EUR 12.6 bn leading companies in the production of steel (no. 1 worldwide in stainless
FFO/Net Debt*.: 21.7% flat steel, no. 6 globally in carbon flat steel). The automotive segment is
Net Debt/EBITDA* : 3.2x
among the world’s leading suppliers of the automobile industry (no. 8). In
EBITDA / net interest: 15.2x
*adjusted addition, the company holds the no. 3 position worldwide in the production
of elevators and escalators.
Strengths/Opportunities – Well diversified business portfolio with strong market positions in its core
businesses.
– Strategic focus on portfolio optimization through an initiated program
through which the portfolio is streamlined in order to concentrate only on
high-performing businesses
– Improved financial profile in FY 2003/2004, mainly driven by the favorable
development in the steel segment as well as internal operational improvement
efforts and positive effects resulting from the portfolio optimization program
Weaknesses/Threats – Operating in challenging, mainly capital-intensive, cyclical industrial sectors,
which are, to a large part, subject to similar economic cycles.
– High unfunded pension liabilities, mainly resulting from benefit obligations in
Germany, increase leverage/indebtedness.
Credit opinion ThyssenKrupp’s credit profile has improved significantly in the last few months
on the back of an ongoing favorable market environment and as a result of
internal operational improvement efforts. The success of these measures was
evidenced in the company’s FY 2003/2004 results as well as in its preliminarily
Q1 FY 2004/2005 results. Credit positive was as well the announced sale of the
company’s real estate unit for EUR 2.1 bn. Going forward, we expect the
company to continuously benefit from the good market conditions in the steel
segment (which should continue at least in 2005). This combined with further
positive effects from the portfolio optimization program should support the
company’s credit profile in the future. Following the approval of the real estate
unit sale by the respective authorities, we view it as likely that S&P will upgrade
the ratings on ThyssenKrupp (currently BB+ cw positive).

Euro High Grade

February 2005
TUI (N.R.); HVB CREDIT RESEARCH RATING: BB+

Bond-Ticker: TUI
Recommendation: Buy Analyst: Carmen Hummel
Business Profile: Initially an industrial conglomerate ("Preussag"), the group was re-named
TUI AG in 2002 (Touristik Union International) and is the number one player
in the tourism industry in Europe. TUI has been in the middle of a transition
Key Indicators FY 2004e
Sales: EUR 17.6 bn process since FY 2000, when it started to dispose of non-tourism business
EBITDA rep. EUR 1.2 bn units. Proceeds from the divestments have been consequently utilized for
Net debt rep.: EUR 3.3 bn debt reduction. Hence, TUI's net debt decreased by more than EUR 3.6 bn
Net debt/EBITDA rep.: 2.8x during the last three financial years. In FY 2004, TUI did its homework,
Net debt/EBITDA adj.*: 4.6x
significantly enhancing its debt maturity profile. Also, it had to cope with a
EBITDA/net int. rep.: 6.6x
EBITDA/net int. adj.*: 3.5x number of unfavorable issues: (A) potential elimination from the DAX – in
the end, TUI remained a member of the DAX (B) tourism slump after 9/11 –
*pension/lease-adjusted strong recovery in 2004 (C) IPO of its Hapag Lloyd division – cancellation, as
TUI (a) would not receive the targeted price and (b) TUI was not dependent
on the proceeds after the successful refinancing restructuring, (D) rumors
about an unfriendly takeover in connection with the 31.3% WestLB stake
which was for sale until the beginning of December. The stake was sold to
various strategic buyers and to the public, making it the best possible
outcome.
Excellent news: the outcome of The Riu family and TUI have known each other for decades, through
the WestLB disposal
cooperation and strategic partnerships. For example, TUI and the family-owned
Riu Group jointly own Riusa II (50/50 JV) and Riu Hoteles SA (TUI share: 49%).
Moreover, the significantly increased freefloat of TUI shares to 82.6% fortifies
the company’s positioning in the DAX, pushing it to rank 30 (from last place,
35). TUI has gone through hard times in 2004 and has solved a significant
number of issues and, with the divestment of WestLB’s share, the last remaining
task on the list has been resolved. Now TUI can concentrate on achieving its
targets, i.e., profitability enhancement, asset disposals and debt reduction, in
short, on improving its credit profile in order to attain an investment-grade
rating by November 2005.
Credit metrics currently equal a Current financials and credit metrics equal a mid-to-high BB rating. Should TUI
mid-to-high BB rating
achieve its objectives for debt reduction and profitability improvement, a credit
profile corresponding to a low BBB rating is possible by FYE 2005.
Improvements in credit We expect TUI’s credit metrics to markedly improve from FY 2005 on. We
protection ratios from FY 2005
onwards
anticipate the turnaround in TUI’s credit profile will be visible in FY 2006. We
assume the adjusted EBITDA margin (FY 2003: 8.1%) to improve to 11.3% in FY
2006. Also, by the end of 2006, the adjusted EBITDA net interest coverage ratio
should recover to 5.4x (from 3.8x in FY 2003). Based on our estimates for total
proceeds coming from further disposals and assuming accumulation of free cash
flow after capex of more than EUR 700 mn, adjusted net debt/EBITDA at FYE
2006 should improve to 2.9x (from 4.5x at FYE 2003).
Industry-related risks diminish Risks would be another slump of the tourism industry caused by unforeseeable
events, similar to September 11. However, we deem another slump as rather
unlikely, as even the Tsunami disaster did not really hit the tourism industry
(travelers changed destination plans). As the divestment of WestLB’s stake has
been resolved, the risk of an unfriendly takeover has diminished, as did the risk
of asset stripping.

Euro High Grade

February 2005
FUNDAMENTAL CREDIT VIEWS – THE “USUAL SUSPECTS”
Current Ratings Credit

(Moody's/S&P/Fitch) Profile
Aa3s/AA-n/Ap Improving Allianz Group (ALZ): Marketweight Analyst: Luis Maglanoc
It is one of the world's largest financial services firms. Net income in 9M 2004 was EUR 1.828 mn
vs. EUR 732 mn in the previous year, due to improved operating results, especially in the P&C unit,
helped by higher investment income. Net income in P&C surged by 53.4%, reaching EUR 2.247 mn.
Premium income at the P&C unit rose by 1.3% to EUR 34.6 bn, whereas the claims ratio fell to
68.2% vs. 71.7% y-o-y, despite the hurricanes, which affected Allianz with EUR 216 mn. The
combined ratio improved to 93.2%, following 96.9% in 9M 2003. The life sector posted good results,
with net income climbing by 57.8% y-o-y to EUR 508 mn. Premium income rose by 4.5% to EUR 32
bn. We view Allianz' milestones as improving the company's credit profile and as easing pressure on
ratings. Spreads still have tightening potential and we recommend to buy the ALZ 6.125% 05/22.
Aa3s/AA-s/AA-s Improving BASF (BASF): Underweight Analyst: Jochen Schlachter
We continue to expect a strong performance at BASF following a very strong Q3, with both sales and
profits growing well in the double-digit range. Its credit profile remains excellent. BASF recently
bought Merck's electronic chemicals business for EUR 270 mn. More acquisitions with a similar
price tag would neither be a surprise nor a concern to us. A potential spin-off or exit of its Basell JV
would be positive. The outlook for the full year was changed and the company now expects a
significant increase in sales and EBIT. We note that BASF managed to partly offset rising oil and
raw material prices through its oil activities, which create a natural hedge against oil price
fluctuations. On the negative side, we note that the company continues to pursue an aggressive
share buy-back strategy. Overall, we continue to believe that the bonds trade too tight.
A3s/As/--- Stable Bayer (BYIF): Marketweight Analyst: Jochen Schlachter
For FY 2004, we expect Bayer Material businesses to show improving results on the back of strong
demand in the wake of the economic recovery, while earnings at its Lanxess sub-group should be
impacted by further restructuring charges. Lanxess has been listed in the meantime and the spin off
completed. Bayer's HealthCare business is expected to have turned the corner in 2004, despite an
increase in provisioning for Baycol reported in Q3. Recently, the company announced it had 6,359
Baycol cases outstanding, 810 fewer than before, with many of them being withdrawn for lack of
evidence. However, we expect that the pharma segment will remain laggard both in growth and
profitability in the near to medium term. Overall, we think that Bayer's bonds are fairly priced.
A1s/---/--- Stable BMW AG (BMW): Marketweight Analyst: Dr. Sven Kreitmair
BMW's industrial total debt/EBITDA (adjusted) remained at 0.9x in LTM 9M 2004. This ratio ranged
between 0.9-1.0x since FY 2000, which demonstrates the stability and robustness of BMW’s credit
profile. BMW’s industrial EBIT should decline by 1% in FY 2005e and by 3% in FY 2006. This is
mainly due to negative factors like the increase in the price of raw materials and from adverse
exchange rates due to low hedging ratios, combined with unfavorable rates for the additional
hedging undertaken in the course of 2004. Moody’s stated that the prerequisite for a rating upgrade
would be a sustainable higher level of industrial free cash flow generation that would result in an
increasing net industrial cash position and conservative leverage of the financial services operations.
Key to these improvements is the preservation of the premium pricing position and brand value
despite increasing competition in the luxury market segments. BMW’s credit profile in FY 2005e
profits additionally from the cash payment of EUR 1 bn from Ford on June 30, 2005 for the sale of
Land Rover. With the outlook of robust and likely improving automotive free cash flow generation in
FY 2005 (partly offset by the weaker USD), as well as low headline risk and spread volatility, we
think that bonds are fairly priced.
A2s/A-s/A-p Improving Commerzbank (CMZB): Marketweight Analyst: Luis Maglanoc
#4 German bank; strong in Mittelstand and Internet banking, is restructuring its operations. CBK
reported a Q3 2004 net loss of EUR 208 mn, due to a trading loss of EUR 9 mn, and EUR 132 mn
restructuring expenses for CBK Securities. 9M 2004 net income was EUR 294 mn (9M 2003: EUR -
2.232 mn), as the prior period's huge restructuring costs were not repeated, and all business
segments continued their positive development, except Securities. Cost-income ratio improved to
68.5% (72.4%), while Tier 1 ratio was 7.2% (7.3%). Credit quality continued to improve with NPLs
declining 6.3% from Dec 2003, and NPL coverage rising to 91.1% (83.7%). Fitch reiterated its
positive outlook, putting emphasis on the restructuring of CBK Securities and renewed focus on
CBK's core retail and corporate customers. Spreads remain tight.
Baa2p/BBB+s/--- Stable Continental AG (CONTI): Marketweight Analyst: Dr. Sven Kreitmair
FFO/net debt (adjusted) improved to 37.5% vs. 30.5% in FY 2003 (hurdle for S&P’s BBB+ rating is to
stay at least 35%). For 2005, Conti expects its sales and operating results to increase, again over
2004 levels, meaning that the passenger and light truck tire business will break even in Q4 2005 in
the NAFTA region. Moody’s stated that any improvement in its current rating is likely to be driven
by signs of continuing improvement in the US business as evidenced by the successful execution of
restructuring measures according to the company's own targets, combined with an extended track
record of solid free cash flow generation and relatively strong credit metrics. Although spreads
discount an upgrade to A-, we still believe that the spread level is fair.

Euro High Grade

February 2005

A3s/BBBs/BBB+p Stable DaimlerChrysler AG (DCX): Overweight Analyst: Dr. Sven Kreitmair
Automotive net debt/EBITDA (adjusted) stayed unchanged at 2.4x in LTM 9M 2004 compared to
LTM H1 2004. We calculated an improvement to 2.3x by FYE 2005-06e, which is commensurate
with a BBB+ rating level. In 2005, DCX's automotive credit profile could also profit from a potential
solution at its loss-making Smart unit, from Mitsubishi Motors for its acquisition of Fuso trucks and
a disposal of MTU Friedrichshafen. In this case and assuming a further conservative debtholder-
friendly financial policy and the achievement of current consensus forecasts, DCX's spread levels
would have the chance to tighten to A- levels. Therefore, we believe that there is value in DCX
bonds.
Aa3s/AA-s/AA-s Improving Deutsche Bank (DB): Marketweight Analyst: Luis Maglanoc
#1 German bank in assets; over the past five years, DB has transformed itself into a global
investment bank with a top-tier franchise and is a global leader in fixed income products. DB
launched a radical restructuring program in August 2002 aiming to cut costs and to improve capital
allocation across the group. In December 2004, DB announced a second efficiency program and
targeted a 25% pre-tax ROE by the end of 2005. FY 2004 net income surged 86.5% to EUR 2,546
mn, despite the EUR 574 mn reorganization expense in Q4 as revenues were resilient (+3.1%), being
supported by net fees, trading and net gains on securities and investments, offsetting the decline in
net interest. Costs were reduced (-3.0%), as well as provisions (-66.5%). Hence, the cost-income ratio
improved to 79.4% (81.8%), while Tier 1 remained at a strong level of 8.7% (10.0%). Improving
credit metrics are already priced in, and while we do not expect immediate rating adjustments, we
have a positive outlook on DB, which succeeding quarters should confirm.
A1n/As/A+s Stable Deutsche Post Worldnet (DPW): Underweight Analyst: Dr. Sven Kreitmair
Q3 EBITA of EUR 575 mn was largely in line with consensus expectations. Net debt/EBITDA in LTM
9M 2004 (Postbank at equity) was unchanged at 2.0x compared to LTM H1 2004. Although we
believe that the debt leverage is somewhat high for an A/A+ rating, the company profits from its
valuable remaining 66.8%-stake in Postbank and the direct/indirect 67.6%-ownership of the German
state. Bonds tightened recently as the company bought back EUR 114 mn of its 2007 bond, EUR 71
mn of its 2012 bond and EUR 74 mn of its 2014 bond. Nevertheless, we remain on underweight for
the name given little upside potential at current spread levels, while acquisition risk remains (e.g.
European post consolidation, KarstadtQuelle Logistics, Asia, etc.).
Baa1s/BBB+p/A-s Improving Deutsche Telekom (DT): Marketweight Analyst: Stephan Haber
Deutsche Telekom AG released mixed subscriber numbers for Q4 2004 with still strong customer
growth in the US and in the UK but with weak numbers in its domestic mobile market. However, we
expect still strong Q4 results, as the low subscriber growth, driven by lower (handset) subsidies,
should support profitability improvements. In addition, we expect strong net debt reduction in Q4
supported by the sale of a 15% stake in MTS for ~USD 1.7 bn. However, given that the company
indicated a higher-than-expected dividend payment for FY 2004 and already dedicated its FCF in FY
2005 to dividend payments, acquisitions and additional capex, further credit quality improvements
will be less significant in 2005. We expect DT to protect its YE 2004 financial profile in 2005 while
its business profile should mildly benefit from an improving business profile in the US and from
acquisitions, e.g. in Poland. DT's new jumbo bond issue (in January) in the amount of EUR 3.0 bn
did not impact spread levels. We see fair value in the name. (March 3: Q4 2004 results)
Aa3s/AA-s/AA-s Stable E.ON (EOAGR): Overweight Analyst: Christian Kleindienst / Stephan Haber
E.ON released its new investment plan for 2005–2007, increasing, as expected, total investments by
EUR 4.9 bn compared to the previous plan 2004-2006. Previously, it released strong 9M results
above expectations, with an increase in adj. EBIT by 19% and a positive surprise at the net income
level. E.ON further reduced its net debt level by around EUR 2 bn to EUR 8 bn in the past quarter
due to strong cash flow generation and proceeds from asset disposals. The overall outlook for full FY
2004 remains positive. E.ON recently announced two Eastern European acquisitions: the gas
business of the Hungarian MOL for a total of up to EUR 2.1 bn and the Romanian gas supplier
Distrigaz Nord for EUR 303 mn. The transactions are in line with previously announced expansion
plans. Due to the strong operational performance and a promising earnings outlook, we see
sufficient financial headroom for the announced acquisitions and see further spread tightening
potential.
A2n/A-s/--- Weakening Henkel (HENKEL): Marketweight Analyst: Carmen Hummel
Henkel's Q3 figures were in line with expectations and influenced by the Dial acquisition. More
important was Henkel’s agreement with Clorox (completed in October), resulting in the
discontinuance of the partnership between the two, generating around USD 2.1 bn in cash for
Henkel. From the proceeds, the company intends to utilize USD 1 bn for debt reduction, while the
remaining USD 1.1 bn should be used for “further growth”. As Henkel’s ratings were closely linked
to the commitment of using around USD 1.6 bn from disposal proceeds for debt reduction, S&P
downgraded its rating by one notch and we expect Moody's to follow with a rating action during the
next six months. We think that the HENKEL 06/13 bond is fairly valued and have the bond as a core
hold in our model portfolio (FY 2004 results: February 22).
A3n/A-wn/A-s HypoVereinsbank (HVB):
No HVB Credit Research coverage.

Euro High Grade

February 2005

A3s/BBB+s/--- Improving Linde AG (LINDE): Underweight Analyst: Jochen Schlachter
We expect both of Linde's divisions Material Handling and Gas & Engineering to have performed
well in the current environment. However, we continue to view Linde's balance sheet as fairly
stretched, although we acknowledge the company's deleveraging efforts. The company has
reiterated its outlook for the year 2004 with earnings expected to be above the previous year's
results. Recently, the company experienced a setback when the European cartel office revoked its
patent for the use of nitric oxide to treat respiratory failure. The company also secured further
orders in China where it is currently weakly positioned compared to its peers. However, we note
that the patent is still valid in the US. Overall, we believe that the bond trades too tight for the rating
class.
Baa1n/BBBs/BBBs Stable Metro (METFNL): Overweight Analyst: Carmen Hummel
Q4 sales (+5.5% to EUR 16.8 bn) came in below Metro's full year guidance of 6% sales growth net of
currencies and were due to an unusually weak after-Christmas business week. Metro confirmed,
however, that it would achieve its EPS growth target of 6-10% pre non-recurring expenditures and
we are confident that profitability and credit metrics have remained stable. Our expectation is also
underpinned by the fact that Metro has further increased its share of international sales (49% of
consolidated turnover in FY 2004 vs. 47% at FYE 2003). Outside Germany, Metro generates higher
margins and thus, the higher proportion of sales will result in improved overall profitability and
credit metrics. As we are of the opinion that Metro bonds offer value, we keep the METFNL 02/08
and the METFNL 05/11 in our portfolio. (FY 2004 results: March 22)
Aa3n/A+s/AAn Improving Munich Re (MUNRE): Marketweight Analyst: Luis Maglanoc
It is the largest property & casualty reinsurer in the world, as well as the second largest life
reinsurer. FY 2003 saw a net loss of EUR 434 mn, which was worse than expected, due to a tax
charge of EUR 1.8 bn. In 9M 2004, the reinsurer posted EUR 1.527 mn in net income vs. a EUR 487
mn net loss in 9M 2003. Results were helped by a 43.7% surge in investment results to EUR 5.7 bn.
The reinsurance unit contributed EUR 1.387 mn to the group's profit, as it managed to keep both
the claims and the retention for primary insurers at low levels. The combined ratio in reinsurance
was 98.8% vs. 97.0% y-o-y due to the effects from natural catastrophes. The primary insurance unit
posted a combined ratio of 92.2% vs. 96.3% y-o-y, reflecting strong progress in its fundamentals.
Due to the stable fundamentals, we keep our core hold recommendation on the MUNRE 6.75%
06/23.
A1n/A+n/A+s Stable RWE (RWE): Marketweight Analyst: Christian Kleindienst / Stephan Haber
RWE reported strong results for 9M 2004 and basically confirmed its outlook for 2004. Group
operating result increased by 12.6% y-o-y to EUR 4.46 bn. Excluding the effect of the
deconsolidation of Consol and negative currency effects, the increase would have been 15%. Cash
flow from operating activities declined by 5% y-o-y to EUR 3.77 bn, mainly due to the absence of
cash flows from Consol and increased expenditures on restructuring. However, free cash flow rose
from EUR 1.01 bn to EUR 1.55 bn, benefiting from significantly lower capex. Reported net debt at
the end of Q3 2004 was down to EUR 14.5 bn, mainly due to proceeds from asset disposals.
However, the net debt target of EUR 17 bn by 2005 was confirmed, excluding proceeds from the
disposal of non-core businesses, as these proceeds will not be used for debt reduction but rather for
acquisitions. The successful deleveraging brought credit metrics back in line with a strong single A
profile, matching current spread levels. (Q4 results: February 24)
Aa3s/AA-s/AA-s Stable Siemens AG (SIEM): Marketweight Analyst: Stephan Haber
Siemens AG released mixed Q1 FY 2005 results with revenues below, and profitability above market
consensus. Orders increased by 5% y-o-y to EUR 21.54 bn and sales fell by 1% y-o-y to EUR 18.2 bn
(market consensus EUR 19.2 bn). Group operating profit increased by 5.3% y-o-y to EUR 1.43 bn
which was significantly above the market consensus of EUR 1.32 bn. The operating profit was
positively impacted by a gain from the sale of a portion of shares in Juniper Networks Inc. Net
income with EUR 1.001 bn was also above the market consensus of EUR 835 mn. The company was
still net cash positive (EUR 273 mn). Credit protection ratios remained strong. According to Moody’s,
the absolute size of the VA-Tech acquisition would fall within the EUR 2.0 bn annual acquisition
headroom, which is factored into the Aa3 rating. We continue to see fair value in SIEM bonds.
A3n/A-n/A-n Improving Volkswagen AG (VW): Overweight Analyst: Dr. Sven Kreitmair
VW’s industrial credit metrics improved slightly to 1.5x in LTM 9M 2004 vs. LTM H1 2004, which
was better than expected. Positive was that the company confirmed its FY 2004 forecast as the
ForMotion program contributed more than EUR 850 mn in 9M 2004 (H1 2004: EUR 400 mn) to its
operating profit. Positive for debtholders was that free operating cash flow after capex improved to
EUR 1,164 mn in 9M 2004 vs. EUR -1,029 mn a year earlier on higher FFO, better working capital
management and a reduction in capex/sales ratio to 6.4% from 8.2% in 9M 2003. To summarize, Q2
and Q3 showed the success of the ForMotion program in the automotive cash flow statement and
balance sheet and the commitment of the company to keep its A- rating. Should VW be able to raise
its operating profit in 2005 (please refer to our Credit Flash dated October 29) and keep its credit
metrics below an automotive net debt/EBITDA (adjusted) of 2.0x, we even see spread tightening
back to A- levels this year. Despite recent spread tightening, we still see value in the name.

Euro High Grade

February 2005
DISCLAIMER
Please note
Key 1: Bayerische Hypo- und Vereinsbank AG and/or a company affiliated with it pursuant to § 15 AktG (German stock-company act) owns at
least 1% of the capital stock of the company.
Key 2: Bayerische Hypo- und Vereinsbank AG and/or a company affiliated with it pursuant to § 15 AktG (German stock-company act)
belonged to a syndicate that in the last five years prior to publication of this analysis has acquired securities of the company.
Key 3: Bayerische Hypo- und Vereinsbank AG acts as stabilizing manager or sponsor, e.g. as designated sponsor of the analyzed securities on
the stock exchange or the open market on the basis of an agreement with the company.
Key 4: Bayerische Hypo- und Vereinsbank AG and/or a company affiliated with it pursuant to § 15 AktG (German stock-company act) hold a
short position of at least 1% of the capital stock of the analyzed company at the end of the month prior to the date on which the
analysis was compiled.
Company - Key: Adidas 2, Allianz 2, BASF 2, Bayer 2, BMW 2, Commerzbank 2, Continental 2, Deutsche Bank 2, Deutsche Börse 2, Deutsche
Post 2, Deutsche Telekom 2, Fresenius 2, Henkel 2, Infinion 2, Linde 2, Lufthansa 1, 2, MAN 2, Metro 2, Munich Re 1,2, RWE 2, Siemens 2,
ThyssenKrupp 2, Tui 2, VW 2.
Bayerische Hypo- und Vereinsbank AG and companies affiliated with it pursuant to § 15 AktG (German stock-company act) regularly trade
shares of the analyzed company.
Disclaimer:
Our recommendations are based on public information that we consider to be reliable but for which we assume no liability especially with
regard to its completeness and accuracy. We reserve the right to change the views expressed here at any time and without advance notice. The
investment possibilities discussed in this report may not be suitable for certain investors depending on their specific investment target or time
horizon or in the context of their overall financial situation. This report is provided for general information purposes only and cannot be a substitute
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Please note that the provision of investment services may be restricted in certain jurisdictions. You are required to acquaint yourself with any
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This report is intended for clients of Bayerische Hypo- und Vereinsbank AG who are market counterparties or intermediate customers (both as
defined by the Financial Services Authority (“FSA”) and is not intended for use by any other person, in particular, private customers as
defined by the rules of FSA. This report does not constitute a solicitation to buy or an offer to sell any securities. The information in this
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environments and other factors relating to the foregoing.
All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement.

Euro High Grade

February 2005
CONTACTS
Global Head of Research
Thorsten Weinelt, CFA
Managing Director
+49 89 378-15110
thorsten.weinelt@hvb.de
FX/FI & FX/FI Derivatives Strategy High Grade Research*

Michael Rottmann, Head Luis Maglanoc, CFA, Head
+49 89 378-15121 Financials
+49 89 378-12708
Kornelius Purps, FI-Strategy
+49 89 378-12753 Stephan Haber
Telecoms, Media, Technology
Herbert Sellier, Technical Analysis
+49 89 378-15192
+49 89 378-18024
Dr. Sven Kreitmair
Herbert Stocker, Technical Analysis
Automobiles & Parts, Industrial G&S,
+49 89 378-14305
Aerospace & Defense
Armin Mekelburg, FX-Analysis +49 89 378-13246
+49 89 378-14307
Carmen Hummel
Dr. Stefan Kolek, EEMEA Strategy Food & Beverage, Personal & Household Goods,
+49 89 378-12495 Retail, Travel & Leisure
+49 89 378-12252
Frauke David, EEMEA Strategy
+49 89 378-13247
High Yield* & EEMEA Credit Research
Credit & Credit Derivatives Strategy Dr. Felix Fischer, CFA, Head
General Industries, Basic Resources,
Dr. Jochen Felsenheimer, Head
Construction & Materials, Tobacco
+49 89 378-18188
+49 89 378-15449
Dr. Philip Gisdakis
Jochen Schlachter
Quantitative Credit Strategy
Chemicals, Healthcare
+49 89 378-13228
+49 89 378-13212
Michael Zaiser
Jana Arndt
Credit Strategy
+49 89 378-13211
+49 89 378-13229
Dusan Meszaros, EEMEA Credit
+43 50505-82350
Covered Bond & Agency Research dusan.meszaros@BA-CA.com
Bernd Volk, CFA, Covered Bonds
+49 89 378-18133
Florian Hillenbrand, Covered Bonds * Crossover credits are covered by the
+49 89 378-12961 respective high-grade sector analyst
Valentina Stadler, Sub-Sovereigns & Agencies
+49 89 378-16296
Securitization Research
Helge Münkel
+49 89 378-11294
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(HVB Group) Trading The DAX in CDS Format and Playing Equity Versus Debt

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(HVB Group) Trading The DAX in CDS Format and Playing Equity Versus Debt

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Global Markets Research

Euro High Grade

Credit Derivatives Special

TRADING THE DAX IN CDS FORMAT ...

© HVB Corporates & Markets, Global Markets Research.

Credit Derivatives Special - Trading the DAX in CDS format ...

CDS QUOTES FOR THE DAX 30

© HVB Corporates & Markets, Global Markets Research. 2

Credit Derivatives Special - Trading the DAX in CDS format ...

THE DAX 30 UNIVERSE

DAX 30 INDEX – OVERVIEW*

© HVB Corporates & Markets, Global Markets Research. 3

Credit Derivatives Special - Trading the DAX in CDS format ...

THE ABSENCE OF A REFERENCE OBLIGATION

THE BASIC MERTON APPROACH

© HVB Corporates & Markets, Global Markets Research. 4

Credit Derivatives Special - Trading the DAX in CDS format ...

INHERENT PROBLEMS WHEN DEALING WITH MERTON MODELS

Source: Fraunhofer Institut, HVB Global Markets Research

© HVB Corporates & Markets, Global Markets Research. 5

Credit Derivatives Special - Trading the DAX in CDS format ...

Merton Credit Duffie/ Zhou Black/Cox Market

© HVB Corporates & Markets, Global Markets Research. 6

Credit Derivatives Special - Trading the DAX in CDS format ...

HVB’S RATING APPROACH

© HVB Corporates & Markets, Global Markets Research. 7

Credit Derivatives Special - Trading the DAX in CDS format ...

ARBITRAGE BETWEEN EQUITY & DEBT

CDS AND IMPLIED OPTION VOLATILITY FOR DT AND ALLIANZ (SUBS)

Source: Bloomberg, HVB Global Markets Research

© HVB Corporates & Markets, Global Markets Research. 8

Credit Derivatives Special - Trading the DAX in CDS format ...

A CREDIT INDEX SWAP FOR THE DAX 30 AS THE NEXT STEP

© HVB Corporates & Markets, Global Markets Research. 9

Credit Derivatives Special - Trading the DAX in CDS format ...

HETEROGENEITY WITHIN THE DAX 30 BASKET RESULTS IN A NOTABLE DISPERSION BIAS*

© HVB Corporates & Markets, Global Markets Research. 10

Credit Derivatives Special - Trading the DAX in CDS format ...

FUNDAMENTAL CREDIT VIEWS – THE EIGHT “EXOTICS”*

ADIDAS-SALOMON AG (N.R.); HVB CREDIT RESEARCH RATING: A

© HVB Corporates & Markets, Global Markets Research. 11

Credit Derivatives Special - Trading the DAX in CDS format ...

ALTANA AG (N.R.); HVB CREDIT RESEARCH RATING: A3

© HVB Corporates & Markets, Global Markets Research. 12

Credit Derivatives Special - Trading the DAX in CDS format ...

DEUTSCHE BÖRSE AG (AA1/P-1 STABLE; AA+/A-1 STABLE)

© HVB Corporates & Markets, Global Markets Research. 13

Credit Derivatives Special - Trading the DAX in CDS format ...

INFINEON TECHNOLOGIES AG (N.R.); HVB CREDIT RESEARCH RATING: B+

© HVB Corporates & Markets, Global Markets Research. 14

Credit Derivatives Special - Trading the DAX in CDS format ...

DEUTSCHE LUFTHANSA AG (BAA2S/BBBS/-)*

© HVB Corporates & Markets, Global Markets Research. 15

Credit Derivatives Special - Trading the DAX in CDS format ...

MAN AG (N.R.); HVB CREDIT RESEARCH RATING: BBB+

© HVB Corporates & Markets, Global Markets Research. 16

Credit Derivatives Special - Trading the DAX in CDS format ...

SAP AG (N.R.); HVB CREDIT RESEARCH RATING: A

© HVB Corporates & Markets, Global Markets Research. 17

Credit Derivatives Special - Trading the DAX in CDS format ...

SCHERING AG (A2 STABLE, A STABLE)

© HVB Corporates & Markets, Global Markets Research. 18

Credit Derivatives Special - Trading the DAX in CDS format ...