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In The Press

New Company Bids To Bust Wall St. Hold On Derivative Pricing

from Dow Jones News Service

By Michael Santoli, Dow Jones Staff Reporter

NEW YORK-DJ-Seizing on the buyer-beware sentiment pervading the derivatives market, a former Bankers Trust Co. executive has fashioned a sort of Rosetta stone for users of exotic derivatives.

Rich Tanenbaum, who structured and helped devise pricing models for many over-the-counter derivative structures while at Bankers Trust, is now selling his own option-pricing software.

Called Tanenbaum Option Pricing Software, the technology is meant to break the lock that big Wall Street dealers have on valuing the complex instruments they sell. The product - which is intended for use by corporate treasurers, money managers, auditors and even derivatives dealers themselves - is touted by Tanenbaum as a comprehensive tool for valuing any actual or hypothetical derivative structure that the market might devise.

A corporate treasurer who has bought, or is looking to buy, an exotic OTC option can only get prices by phone from the big dealers who offer such an option. Tanenbaum said in an interview that phone calls to five dealers can yield as many different prices for an option with the same terms. In addition, he said, some products are so customized that an instrument with identical terms often wont be offered by a variety of dealers.

With TOPS, a menu-driven computer program that lets a customer plug in a variety of trade parameters, the treasurer is able to simulate any desired product and determine the "correct" or "fair" price.

This assertion will raise flags on Wall Street, though, because no truly objective price, or pricing model, can exist for a customized derivative product. In fact, the price for an instrument that matters most is the one a dealer is willing to take when you want to buy, not the one that pops on a computer screen.

Tanenbaum, whose Princeton, N.J., company is called Savvysoft, said he considered a couple of possible models and tested them internally. He also said the theoretical model behind TOPS is transparent and intuitive enough for a user to know how it might differ from a dealers model.

Tanenbaums system has already been bought by some of the big six accounting firms, major international banks and multinational corporations. The big derivatives dealers - which consist of several large investment banks and money-center commercial banks - could use the product as a "double check" on its own pricing models.

In addition, he said "second-tier" securities firms looking to sell their own derivatives may be interested in the system as a means of building derivatives structuring capabilities from scratch.

A price for various option structures is attained by plugging several terms into a model menu, such as strike price, expiration and volatility assumptions. Because so many parameters can be tried and changed, the program can serve as a sort of Mr. Potato Head for option pricing, with which a user can move around ears, hats and mustaches on a stable base to create new varieties of derivatives.

Options are in a sense the building-blocks of nearly all types of derivatives, no matter how complex. For this reason, the price and market behavior of most structured derivatives can be determined by variations on basic option-pricing models.

Tanenbaum is pushing his program as a way to prevent blowups such as Procter & Gamble Co.s (PG) loss last year on a complex interest-rate swap position. P&G blamed its dealer, Bankers Trust, for misleading it about the potential risk of the swap.

Bankers Trust also settled a lawsuit with Gibson Greetings Inc. (GIBG), after the company alleged that a BT salesman had given false information about the value of Gibsons derivatives holdings.

In theory, the TOPS software couldve been used by both companies to track the values of their positions. The software also allows users to chart the possible value of an exotic option under various market conditions.

Tanenbaum, who left Bankers Trust derivatives desk in 1989, said that in the course of pre-marketing the product, his company encountered several species of derivatives in use that he hadnt been aware of. He then set out to bring the system up to speed and said it now can handle about anything Wall Street can throw at it. He also plans to update the program as new structures arise.

The TOPS system sells for $1,125 to $2,250 each, with volume discounts available. Tanenbaum said he also is talking with vendors of expensive omnibus trade-processing and analytics systems to get the TOPS program included as a feature.


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