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case, involve derivatives. The structured transaction that
Merrill Lynch offered to Fuji and Norinchukin consisted of two
swaps: (1) A basis swap related to the asset that the banks
would be purchasing (the Chase PPNs), and (2) a hedge swap
related to the liability that the banks would be undertaking in
connection with the issuance of the LIBOR notes. In general
terms, a swap is an agreement between two parties to exchange one
set of payments for another. For example, one party might
exchange payments based on a floating interest rate for a payment
based on a fixed interest rate.
Economically, the Fuji and Norinchukin swaps provided the
banks with both an asset and a liability that were attractively
priced compared to other alternatives in the market. Merrill
Lynch was the counterpart in the swaps.
The Fuji and Norinchukin basis swaps had the effect of
passing to Merrill Lynch the interest payments that accrued on
the Chase PPNs from March 21, 1990 through the date that the
Chase PPNs were terminated. Further, Merrill Lynch made payments
to Fuji and Norinchukin which, when considered in conjunction
with the purchase of the Chase PPNs, enhanced Fuji's and
Norinchukin's returns from the Chase PPNs. The net cash flows
resulting from the combination of the Chase PPNs with the basis
swaps were tied to LIBOR--the interest rate index under which
Fuji and Norinchukin normally conducted business.
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