CHAPTER V DEBT OPTIONS Two kinds of debt options have been approved for trading at the date of this booklet. One kind, called price-based options, are options which give their hold- ers the right either to purchase or sell a specified un- derlying debt security or to receive a cash settlement payment based on the value of an underlying debt security (depending on whether the options are physi- cal delivery or cash-settled options). The other kind, called yield-based options, are options that are cash- settled based on the difference between the exercise price and the value of an underlying yield. The distinc- tions between price-based and yield-based options are fundamental and should be understood by readers interested in investing in debt options. At the date of this booklet, only yield-based options are being traded. Although price-based options have traded in the past and may be traded in the future, no price-based option is traded at the date of this booklet. The principal risks of holders and writers of debt options are discussed in Chapter X. Readers inter- ested in buying or writing debt options should not only read this chapter but should also carefully read Chap- ter X, particularly the discussions under the headings "Risks of Option Holders." "Risks of Option Buyers," "Other Risks," and "Special Risks of Debt Options." RATES, YIELDS AND PRICES OF DEBT SECURITIES To understand debt options. an investor should un- derstand the relationship between the rates or yields, which are different ways of expressing return on debt securities, and prices of debt securities. (Coupon inter- est rates of a debt security express return as a percent- age of the principal amount (par value) of the security. Yields express return (or projected return) as a per- centage of the amount invested.) This relationship, simply stated, is that prices of debt securities move inversely to changes in rates. Declining rates, whether 29 CONFIDENTIAL - PURSUANT