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Derivatives uses at the CAAT Plan

Investments

Derivatives are financial instruments whose values are derived from the value of another instrument - generally financial - called the underlying instrument. The more commonly used underlying instruments are stocks or bonds issued by individual companies or equity and fixed income indexes. Exchange rates and interest rates are also used.

At the CAAT Plan, prudent use of derivatives has been made in the fund for several years. This use is carefully controlled and monitored and is subject to a policy approved by the Board of Trustees.

Index Replication
The first use of derivatives at the Plan was the replication of the U.S. Standard and Poor's 500 index during the time that Canadian pension funds were restricted in their investment in non-Canadian assets. Futures contracts could be used to increase the allocation outside Canada in o rder to better diversify the Fund's investment p o rtfolio, as the contracts did not count as foreign content. Now that the foreign content restriction has been eliminated, it is no longer necessary to use such techniques, although the use of futures can be a cost effective way of gaining exposure to equity and fixed income indexes.

Asset Mix Rebalancing
The fund has an asset mix policy that is derived through an asset liability modeling process and is approved by the Board of Trustees. There is also a Rebalancing Policy requiring that, should market movements cause certain of the asset classes in the fund to deviate too far from the asset mix policy, the fund should be brought back to the policy positions. Because it would be costly to sell physical equities and bonds every time this was required, equity and bond index futures are used for the rebalancing.

Currency Hedging
Hedging is a financial activity that is used to mitigate, or offset, the risk of economic loss arising from changes in the value of financial assets.

At the CAAT Plan, almost half the assets in the fund are denominated in currencies other than the Canadian dollar. As we have seen over the past year or so, fluctuations in exchange rates can be significant, and they can materially affect the value of stocks and bonds that are held in non-Canadian currencies. The Plan has a policy of hedging 50% of the value of the non-Canadian assets in the fund. Forward contracts are used to do this.

Active Management
Some of the investment management firms engaged by the CAAT Plan to manage the assets in the fund have been given the authority to use derivative instruments to actively manage within their respective mandates. This gives the managers more flexibility to take advantage of perceived opportunities. The managers in question include the Plan's active currency managers and one of the fixed income managers.

The main types of derivatives

Forward - a contract to buy or sell an asset at an agreed price at a specified date in the future.

Future - a forward contract that is traded on an organized exchange. It is subject to the guidelines and rules applied by that exchange.

Option - an instrument conveying the right, but not the obligation, to buy or sell another instrument at a specified date (or up to a specified date) for a specified price.

Swap - a contract in which the parties agree to exchange the cash flows, for example dividend or interest payments, of the underlying assets in amounts specified by the contract.

March 2009