Prepared by Dean Witter, Inc.

The U.S. Treasury Department is committed to developing a viable market in inflation-indexed notes and bonds. In late January, it sold $7.0 billion of a 10-year security in this category, which it reopened for an additional $4.0 billion in April. On July 8 the department will sell approximately $8.0 of a 5-year inflation-indexed note, and it October it plans to sell a comparable amount of the same maturity. In 1998, the Treasury will sell an inflation-indexed 30-year bond.

Responding to this growing market, the Chicago Board of Trade has developed corresponding futures contracts and options on futures. Starting July 3, the Board will begin trading inflation-indexed 5-year note and 10-year note futures. They will also launch trading in options on these two contracts.

These new products at the Board should enhance the performance of the following market participants:

1. Investors who want to hedge their existing holdings of inflation- indexed securities or their acquisition cost of future holdings.

2. Dealers who want to hedge their inventory of these securities or their acquisition cost of anticipated inventory.

3. Traders who want to express an opinion on the future rate of inflation, which is implied by the spread between the nominal yield on regular note and bond futures and the real yield on inflation- indexed note and bond futures.

Bonds

These securities are unique in their inflation protection for investors. The coupon rate is fixed and paid semi-annually. But, this interest payment is calculated on a variable principle, which is adjusted for changes in the "CPI for all-urban consumers." At maturity, the investor will receive the return of the inflation-adjusted principal. To prevent the erosion which would occur in times of deflation, the Treasury guarantees repayment of at least 100% of the initial principal amount.

Contracts

These new instruments at the CBOT are similar in form to the existing note and bond contracts and share their most common characteristics. They have serial and quarterly expirations (on the March cycle), and each contract represents $100,000 face value of the underlying security. A "basket" of instruments are eligible for delivery, and a system of conversion factors is used to adjust the delivery price to meet the deliverable coupon rate.

The key difference between regular note and bond futures and inflation-indexed note and bond futures resides in the settlement calculation. Pricing, duration, and conversion factors of the inflation-indexed futures are based on real yields, and the principal at settlement is adjusted for the accumulated inflation up to the settlement date. The conversion factor on an inflation-indexed note or bond future is defined as the price per $1 of a deliverable security with a $1 original principal value that yields 3%, as opposed to a yield of 8% with the traditional futures.

1. Contrary to the common perception, inflation-indexed securities are most attractive to long-term investors when inflation is low, not high. When current inflation is low, future inflation is likely to be underestimated by the nominal yields on traditional securities. Inflation-indexed securities are insurance against such periods of under-estimation.

2. The market's view of future inflation is quite volatile, and this volatility represents a trading opportunity itself, distinct from the outright direction of bond prices. The market's judgment of future inflation can be gauged by the spread between the nominal yield on a given maturity of a traditional bond and the real yield on an inflation-indexed bond of the same maturity. The volatility of this spread is observable in the latest bond rally. From the low in prices on April 11 to the high on June 20, the nominal yield on traditional 10-year T-notes fell 66 basis points. The real yield on inflation-indexed 10-year T-notes fell only 18 basis points. This disparity implies that the market's appraisal of future inflation over the next 10 years fell by 0.48%. Traders can now express an opinion on this implied prediction of inflation by spread-trading regular note futures against inflation-indexed note futures.

July 1, 1997 Dean Witter, Inc.

150 South Wacker Drive, Chicago, Illinois

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