American Underwriters, Inc. - Page 4

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          1988 (Kenilworth's 1987 taxable year).1  Kenilworth had $1,000 of           
          capital stock outstanding at the beginning and end of its 1987              
          taxable year.                                                               
               During all years relevant herein, petitioner and Kenilworth            
          invested primarily in Limited Price Options (LPO's) sold by Bear,           
          Stearns & Co., Inc. (Bear Stearns), and Prudential Bache & Co.              
          (Prudential Bache).  An LPO is an extremely high risk,                      
          sophisticated financial instrument designed for aggressive hedge            
          funds, risk arbitageurs, and professional traders.  In general, a           
          purchaser of an LPO pays 20 percent of the market value of a                
          package of securities in return for the right to buy those                  
          securities at a set price during a set period of time.  Once                
          purchased, an LPO may be traded only with the brokerage firm from           
          which it was purchased.  An LPO is like a conventional option in            
          that it creates leverage to enhance the purchaser's potential               
          gain in a strong market.  However, the premium paid for an LPO is           
          generally lower than the premium paid for a comparable                      
          conventional option because the terms of the LPO provide that it            
          will automatically expire without value whenever the market value           
          of the related securities falls below a set dollar amount                   
          (Expiration Price).  To minimize the risk of loss in a declining            
          market, a purchaser of an LPO may execute an addendum to an LPO             

               1 Kenilworth acquired more than 50 percent of the stock of             
          this subsidiary during Kenilworth's 1987 taxable year.  Unless              
          otherwise indicated, our references to Kenilworth are without               
          regard to its subsidiary.                                                   




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