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July 01, 2007

Comments

Victor Cook, Jr., New Orleans, Louisiana

Jeff,

Yes, my analysis did take into consideration the riskiness of the two mergers.

In Step 5 of the ICEBOT PRICE I concluded:

"My theory predicts ICEBOT would create 54% of the group's future market value, leading to lowball and highball stock price forecasts of $335 and $430 respectively. Since ICE had an historical Beta of 3.2 compared with BOT's Beta of 0.8, I considered this a rather risky combination. So I discounted the forecast June, 2008 stock prices are a rate of 3.3% per quarter."

The effect of a 16.5% annual discount rate on the nominal stock price is large. The risk-adjusted Q2-08 lowball price is $335, while the nominal price is $382. The $47 per share difference is 14%. The risk-adjusted highball price is $430, while the nominal price is $522. The $92 per share difference is 22%. The risk is asymmetrically greater on the highball forecast.

Similarly, in Step 5 of the CMEBOT PRICE I concluded:

"My theory predicts the CMEBOT would create 70% of the strategic group's value, leading to my forecast of lowball and highball stock prices of $713 and $886 respectively. Since CME had an historical Beta of 1.4 compared with BOT's Beta of 0.8, I considered this much less risky combination. So I discounted the June, 2008 stock prices at a rate of 1.1% per quarter."

The effect of a 5.5% annual discount rate on the nominal stock price is relatively small. The risk-adjusted Q2-08 lowball price is $713, which the nominal price is $745. The $32 per share difference is just 4%. The risk-adjusted highball price is $886, while the nominal price is $946. The $60 per share difference is 6%.

In short, I judged the riskiness of an ICEBOT merger to be three times greater than a CMEBOT merger. The net-nominal lowball price difference between ICEBOT and CMEBOT is $15. The net-nominal highball price difference is $32. Pretty close to your estimate of a $30 premium.

Yes, the July 9, 2007 vote will be very interesting.

Thanks again for your insightful questions.

~V

jeff

Dr. Cook, I have not had the time to go through your new extensive analysis. It doesn't surprise me that it's a standoff.

Does your analysis take into account measures of risk. For example, the CME and CBOT merger would have a minimum of integration risk. An ICE and CBOT merger would have an integration risk at least three standard deviations from the mean of the CME/CBOT.

If ICE is akin to buying a junk bond over high grade corporate, isn't ICE's offer far to low given the amount of risk? Shouldn't it be at least 30 bucks or more? One could conclude that if ICE gets the CBOT, they get them on the cheap.

One thing is for sure, the CBOT cannot afford to go it alone. They have lost more than several key employees, have a gutted IT dept, and have put very little Capex into the company since 2002. They have been managed to be merged. They will have to find another partner if CME is rejected.

It will be an interesting vote July 9th!

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