Confidential Presentation :

Structured Products Asia COMPASS Notes

Capitalizing USD Interest Rate Dynamics
November 2007

Executive Summary
Executive Summary

Lehman Brothers COMPASS Notes provide an opportunity to invest in interest rate strategies that have performed well historically across different rate and economic cycles A Dynamic Investment Strategy
Investors usually face a difficult choice between passive and active investment management: Investments based upon static market views may achieve poor performance during certain rate cycles or changes in rate cycles The management cost in actively managed funds can be high and the regulatory treatment of such investments is not always optimal A cost effective alternative is to invest in a dynamic strategy that changes according to the yield curve environment Lehman Brothers has carefully selected strategies based on rigorous and extensive historical back-testing Lehman Strategy Notes have been created to incorporate leverage whilst still ensuring Capital Protection

Introducing the Compass Index

The COMPASS Index is a liquid index based on a dynamic investment strategy that automatically adjusts itself over time in response to changes in the market The underlying strategy is a steepener / flattener position on the US curve that is contingent on the changes in the Fed Funds rate The index is structured so as to offer minimal duration The COMPASS Index is published on Bloomberg to offer maximum transparency to investors

Lehman Brothers COMPASS Notes

The COMPASS Note is a USD-denominated note with a dynamic allocation mechanism that gives participation in the COMPASS Index and provides enhanced returns through leverage while providing full capital protection The note has historically outperformed traditional steepener/flattener positions by providing investors a mechanism that dynamically chooses the curve position based the current short rate cycle

Introducing the COMPASS Index

The COMPASS Index

Positioning for Yield Curve Steepening at Ideal Timing

Historical Analysis Historical Analysis Over the last 15 years, the difference between the actual and predicted 5 year forward CMS 10 year- 2 year Spreads has been overstated by the market 68% of the time This indicates that a steepener strategy will be profitable over the long term
35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0%
-0.5 to 0% 0.0 to 0.5% 0.5 to 1% 1 to 1.5% 1.5 to 2.0% > 2.0%

Excess of Actuals over Predicted Spreads

32.78%

22.82% 19.96% 11.51% 5.92% 6.90%

Overestimation of Flattening

Swap Spreads and Rate Cycles Central banks tightening cycles are associated with higher short term growth and inflation expectations, leading to lower long term rates compared to short term rates thus resulting in curve flattening. The opposite is also true from easing cycles The correlation between the Fed Funds target rates and the 10y-2yUSD spread is -87.2% in the 15 year period starting October 1992
(% )
7.5 6.5 5.5 4.5 3.5 2.5 1.5 0.5 -0.5 1992 1993 1994

Rate Cycles and Swap Spreads

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Fe d Funds Rate

USD 10y - 2y

2006

Index Methodology
The COMPASS Index

Dynamic Adjustment to the position based on Fed Funds Rate

The COMPASS Index involves entering into a duration-weighted pair of USD forward-starting 10-year and 2-year swaps according to the evolution of the Fed Funds target rateBy choosing the Fed Funds target rate as a condition, the index captures any change in the US monetary policy The steepening/flattening Position for any quarter is conditional on the change in the Fed Funds rate during the previous 3-month period as defined below: Compass Strategy Position +1 -1 Curve View Steepening Flattening Condition Fed Fundst =< Fed Fundst-3m (Easing Cycle) Fed Fundst > Fed Fundst-3m (Tightening Cycle)

For any day t within a Calculation Period, Indext is calculated by taking the Index at the end of the previous period, and multiplying it by a factor equal to: One, plus the product of The Position (as defined above) The change in the 10y USD Swap less the change in the 2y USD Swap (duration-weighted ; the forwards versus the actual rates)

The Note Mechanism

The COMPASS Index

The COMPASS Note offers a structured participation on the COMPASS Index using a dynamic allocation approach
The redemption amount for the note is equal to the Capital at maturity with a minimum of 100% plus any coupon payable At the inception of the COMPASS Note, the Capital is equal to 100% of the Face value The Capital at the end of any monthly Allocation Period k is then calculated as the sum of:

Capital at the beginning growing at the 3-month Libor rate Capitalk-1 (1 + 3m LIBOR Daycount Fractionk)

Leveraged return earned on the capital allocated to the strategy Capitalk-1 Exposurek Performancek

Administration Fees, Coupons (Total Fees Daycount Fractionk + Coupons)

The Capital at the beginning of an Allocation Period is then set equal to the Capital at the end of the immediately preceding Allocation Period less fees and any coupon payable in the relevant Allocation Period The Exposure is a function of the performance of the strategy during the preceding Allocation Period, as elaborated in the following slide The Performance of the Strategy during a Allocation Period is defined as the percentage return on the Index during that coupon period

Dynamic Allocation Mechanism

The COMPASS Index

Dynamic Adjustment to the position based on Fed Funds Rate

The core principle of this mechanism is that the percentage allocated to the strategy is a function of the performance. If the strategy performs well, the Exposure is increased providing a higher leverage If the performance decreases, the Exposure is reduced and under extreme scenarios, positions in the strategy might be totally unwound to preserve the capital guarantee at maturity The Exposure to the strategy at the beginning of any calculation period is defined as the product of the Multiplier and the Allocation. The Allocation is defined as the difference between the present value of the Note and the Barrier. The Barrier represents at inception the present value of the guaranteed amount at maturity. This Barrier is fixed and rises linearly to 100% over the life of the note. A Dynamic Investment Strategy Exposure = Multiplier * Distance from Barrier
Note Val
115.0%

Multiplier = 75, if the performance >0.25%, 0 if the performance is <-0.25%, 50 otherwise.

105.0%

If the position at the start and the end of the period are95.0% different, then multiplier is 50 Distance from Barrier = (Capitalt Barriert)/Capitalt Total exposure is capped at 30
85.0%

Distance from Barrier

Note Value

Barrie r

Historical Performance Analysis

Attractive IRR and pickup
We analyze the performance of the compass note net of administration fees Back Testing(*): 10 year note IRR Profile
IRR
20.0% 16.0% 12.0% 8.0% 4.0% 0.0% 1988 1990 1992 1994 1996 1998 2000 2002 2004
The COMPASS Index

Back Testing(*): 5 year note IRR Profile

IRR
20.0% 16.0% 12.0% 8.0% 4.0% 0.0% 1988 1990 1992 1994 1996 1998 2000 2002

IRR of Matured Notes

Average C

IRR of Mature d Note s

Ave rage Annual C oupon

Distribution of IRR 10 year COMPASS Notes

60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0%
Less than 6% 6-8% 8-10% 10-12% 12-14%

Distribution of IRR 5 year COMPASS Notes

30.0% 25.0% 20.0% 26.47% 21.12% 14.68% 17.15% 12.62% 4.12%
Avg=8.40%, Std Dev = 3.16%

Avg IRR=8.62%, Std. Dev =1.34% 52.24%

30.70% 14.93% 1.71% 0.43%

15.0% 10.0% 5.0% 0.0%

Less than 4% 4-6% 6-8% 8-10% 10-12%

3.84%

12-14%

14-16%

IRR

IRR

Please refer to the section on Backtesting Methodology for further details. Past performance is not a guarantee for future results

COMPASS Notes: Indicative Term Sheet

COMPASS Notes Indicative Terms and Conditions

COMPASS Strategy Notes Indicative Terms of the COMPASS Note

Principal: Maturity: Currency: Issuer: Issue Price: Redemption:
USD [ ] 10y USD Lehman Brothers 100% On the maturity Date: The greater of 100% (Principal Protected) and the Capital value of the Notes at maturity All other points in time: Redemption price, subject to the occurrence of a Suspension Event For any day t (except the first allocation period) within an Allocation Period the Capital t shall be equal to: CapitalStart (1+ 3m LIBOR Daycount Fractiont ) plus CapitalStart Exposure Performancet minus [ Coupont + Fees Daycount Fractiont ] For the first day of an Allocation Period the Capitalt is CapitalStart. The Capital at the beginning of an Allocation Period is set equal to the Capital at the end of the immediately preceding Allocation Period less any Coupon that is payable Coupon = max(0, 50% *(Capitalt 105%)/ Capitalt ), paid quarterly If on any day t, (Capitalt Barrier t) is less than 5% of the Barrier at that date, a Suspension Event will be deemed to have occurred, in which case all open positions in the Strategy will be closed and the Allocation will be zero from that point onwards. Here, Barriert is the present value of a ten year zero coupon bond on the first allocation date, that linearly appreciates to 100% over the tenor of the note Quarterly, from and including one Allocation Date to and including the immediately following Allocation Date Management Fees of 1% p.a.

Capital:

Coupon:

Suspension Event

Allocation Period: Fees:

Terms and Definitions

COMPASS Strategy Notes Index Position The Index Position determines whether the Index is on a steepener or a flattener strategy. It is set to +1 if the Fed Funds rate decreased or remained the same during the previous 3-month period. In this case, the Index is a steepener. It is set to -1 if the Fed Funds rate increases during the previous 3-month period. In this case it is a flattener Capital The Capital is equal to 100% at inception and increases during subsequent quarters at Libor plus or minus the performance of the index, less the fees Redemption Amount The Redemption Amount is the Capital at maturity with a minimum redemption of 100% Multiplier The Multiplier factor is determined based on the performance of the strategy in the previous period and the change in the Index Position, if any between the previous and the current coupon periods. If Performancet > 0.25% then allocation = 75*(CapitalStart BarrierStart)/Capitalstart Else if Performancet > -0.25% then allocation = 50*(CapitalStart BarrierStart)/Capitalstart Barrier In respect of any day t within an Allocation Period, Barriert shall be equal to
61% + 39% * t T
COMPASS Notes Definitions and Terms

Where t is the number of days from the Initial Allocation Date to but excluding such day t and T is the total number of days from the Initial Allocation Date to but excluding the Final 8

Terms and Definitions

COMPASS Strategy Notes Suspension Event If on any day t within an Allocation Period, (Capitalt Barriert), as determined by the Calculation Agent in its sole discretion, is less than 5% at any time during such day t, a Suspension Event will be deemed to have occurred on that day t (the Suspension Event Date). The notes shall be redeemed only on the maturity date, and will accrue money market returns for the period between the occurrence of the suspension event and the In case of a Suspension Event Date, the Redemption Price of the note shall be determined in accordance with the following formula: 100% + (Capitalsuspension BarrierSuspesnsion) + Accrued interest on excess of capital over barrier the period beginning with the suspension event and ending on the maturity date
COMPASS Notes Definitions and Terms

Backtesting Methodology
COMPASS Strategy Notes Assumptions, Methodology and Results The notes were backtested to evaluate performance over a 10-year and a 5 year tenor The analysis was run with a provision increase exposure to the strategy to 75 when the performance in the prior period has been better than 0.25% and decrease the exposure to 0 if the performance over the prior period is less than -0.25%, subject to a maximum of 30 The initial leverage is set to the mimimum of 30 or 50 times the difference between the capital and the barrier, calculated as the value of a 10-year/5-year zero coupon note on the effective date The backtest assumes no additional costs to the client other than an administration fee of 1% p.a. on the notional Backtests indicate that no suspension events have occurred in any of the notes issued to date IRR has been provided for all notes issued since 1988 that have attained maturity. For all the notes that have still not matured, the average annual coupon that have been made on the payment dates has been presented We have tested the notes last issued in 2004 October, so that atleast 3 full years of data are available based on which the average coupon is quoted.
COMPASS Notes Definitions and Terms

10