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270116_1.TXT 0001 1 IN THE UNITED STATES DISTRICT COURT 2 IN RE: * COBRA TAX SHELTERS * 3 LITIGATION * * 4 -----------------------* * 5 CARMEL PARTNERS, et al, * * 6 Plaintiffs, * * 7 VS. * NO.: 1:06 cv 8001 * (S.D. Ind.) 8 UNITED STATES, * * 9 Defendant. * ------------------------- * 10 * JS BUCKINGHAM * 11 INVESTMENTS, LLC, et al, * * 12 Plaintiffs, * * 13 Vs. * NO: 05-231 (Ct. Fed * Claims) 14 UNITED STATES, * * 15 Defendant. * -----------------------* 16 * MURFAM FARMS, LLC, * 17 * Plaintiff, * 18 * Vs. * NO: 06-245T through 19 * 06-247T (Ct. Fed USA, NO, * Claims.) 20 * DEFENDANT. * 21 22 23 24 25 0002 1 ******************************************************** 2 ORAL DEPOSITION OF 3 DON CHANCE 4 SEPTEMBER 6TH, 2007 5 ******************************************************* 6 ORAL DEPOSITION OF DON CHANCE, produced as a witness 7 at the instance of the DEFENDANT, and duly sworn, was 8 taken in the above-styled and numbered cause on the 2nd 9 of August, 2007, from 9:49 a.m. to 5:13 p.m., before 10 Tammy Staggs, CSR in and for the State of Texas, 11 reported by machine shorthand, at the law offices of 12 Meadows Collier, LLP, 901 Main Street, Suite 3700, 13 Dallas, Texas, pursuant to the Federal Rules of Civil 14 Procedure and the provisions stated on the record or 15 attached hereto. 16 17 Page 1

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270116_1.TXT 18 19 20 21 22 23 24 25 0003 1 A P P E A R A N C E S 2 FOR THE PLAINTIFFS: Sarah Q. Wirskye, Esq. 3 MEADOWS COLLIER, LLP 901 Main Street 4 Suite 3700 Dallas, Texas 75202 5 214.744.3700 214.747.3732 - Fax 6 7 FOR THE DEFENDANT, UNITED STATES GOVERNMENT: 8 Dennis M. Donohue, Esq. UNITED STATES DEPARTMENT OF JUSTICE 9 Tax Division PO Box 403 10 Washington, D.C. 20044 202.307.6492 11 202.307.2504 - Fax 12 Joe Pitzinger, III, Esq. UNITED STATES DEPARTMENT OF JUSTICE 13 Tax Division 717 North Harwood 14 Suite 400 Dallas, Texas 75201 15 214.880.9728 214.880.5741 - Fax 16 17 ALSO PRESENT: 18 Devin Brosseau, CFA 19 20 21 22 23 24 25 0004 1 INDEX 2 3 4 5 6 7 8 9 10 11 12 13 Appearances..................................... Exhibit List.................................... Stipulations.................................... DON CHANCE: EXAMINATION BY MR. DONOHUE................. Signature and Changes........................... Reporter's Certificate.......................... REQUESTED DOCUMENTS/INFORMATION (None) Page 2 PAGE 2 5 6 6 274 276

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270116_1.TXT 14 15 16 17 18 19 20 21 22 23 24 25 0005 1 NO. 2 2369 3 4 2400 5 6 7 8 9 2406 10 11 12 13 2429 14 15 16 2806 17 18 19 20 21 22 23 24 25 0006 1 2 3 4 5 6 7 8 9 10 11 12 2807 Bates stamped DB COBRA 04211, Option Deal Entry.................................... Document labeled Details for Trade 27919A-RMSRPT............................ 24 20 2434 Dr. Kolbe's rebuttal report to Dr. Chance and Dr. Hess............................. Dr. Kolbe's expert report in the JBJZ case..................................... 92 30 2415 2428 Don Chance's rebuttal report in the Murfam Farms case........................ Dr. DeRosa's original report............. Dr. DeRosa's rebuttal report to Dr. Chance and Dr. Hess...................... 42 30 -2402 2404 2405 Don Chance's Expert Report in the JBJZ case..................................... Don Chance's Report in the Murphy Case... Don Chance's Report in the Tesoro Case... Don Chance's rebuttal report in the JBJZ case dated June 20, 2007................. 8 32 32 192 E-mail cited in one of the Government's expert's report, subject: RGI Investments, LLC ........................ 219 DESCRIPTION CERTIFIED QUESTIONS (None)

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P R O C E E D I N G S (All exhibits were pre-marked.) MR. DONOHUE: Let me state that this deposition is being taken pursuant to an agreement of the parties as to time, place, and date and also is being taken pursuant to the Federal Rules of Civil Procedure. DON CHANCE, Having been first duly sworn, testified as follows: EXAMINATION BY MR. DONOHUE: Q. Good morning, Dr. Chance. Page 3

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270116_1.TXT A. Good morning. Q. Would you prefer that I refer to you as Dr. Chance or Professor Chance or do you have a choice on that? A. Everybody asks me that, and I just say it doesn't really matter. It's up to you. Q. All right. Well, if it's okay with you, I'll refer to you as doctor. A. That's fine. Q. Anyone who gets a PhD in my view should have the privilege of being referred to by their title. A. Well, attorneys have JD as I understand, so I think we can call you doctor as well. Q. doctors. But it's not a convention we be called

All right. Could you tell us where you reside? A. I reside in Baton Rouge, Louisiana. Q. And have you ever had your deposition taken before? A. Yes. Q. And approximately how many times? A. A deposition I think I've done once. Q. And when you say that, have you testified in court before? A. Yeah. I was -- I'm separating that from a deposition. Q. Okay. And approximately how many times have you testified in court? A. Two times. Q. Well, since you had your deposition taken once before, you know what the procedure is. A. Yes. Q. The procedure -- and just to refresh your recollection -- I will ask questions and the court reporter is here to take down my questions and your answers. If my questions are unclear to you, just let me know and I'll do the best I can to rephrase the question. Do you understand that? A. Yes, I do. Q. Okay. Another sort of ground rule is is that we can't be speaking at the same time. A. Right. Q. So you have to wait until I complete my question. A. Right. Q. And sometimes that's going to be a problem because I -A. Sure. Q. -- have a tendency to be thinking. And so you have to wait until I'm totally finished with my question. A. All right. Q. Is that clear? A. Yes, I understand. Q. And this is just a formality, but is there any reason this morning and today that you cannot give a full, accurate, and complete testimony? For example, is there any reason why your judgment may be impaired for any reason? A. No. Page 4

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270116_1.TXT Q. Okay. All right. With that in mind, why don't we first start with your report in the JBJZ case, which is Exhibit 2400. I'm going to ask that you be given a copy of that. (Counsel hands document to witness.) Q. (BY MR. DONOHUE) All right. Dr. Chance, is this the report you prepared in the JBJZ case? A. Well -Q. Exhibit 2400? A. It looks like it. Q. Okay. And am I correct that for that report and your other reports you have prepared, you have attached your curriculum vitae, what is known as your CV, as an -A. That is correct. Q. -- appendix to your report, correct? A. That's correct. I thought you had stopped. Q. I told you we would have problems with this. A. You're trying to trick me up. Q. Okay. Could you turn to your appendix? I believe it's on -- your CV rather, which is on page 58. And am I correct that your CV lists essentially what is your employment-related background after your education? A. Yes. Q. Am I correct? A. As well as before. Q. And looking at it, I did not see any indication that you had a background in foreign exchange, either as a trader or any other aspect of foreign exchange. Is -- do you have any experience in that area? A. I'm not a practitioner in that area. I am an academic. I do have banking experience. But you're correct, I'm not a trader or practitioner in the area of foreign exchange. Q. Okay. You mentioned you have banking experience. What was that experience? A. Well, it's on my vitae. It says 1973 to '77, First National Bank of Birmingham, which is currently known as AmSouth, and my position was called assistant cashier and corporate services manager. And I was involved in providing services -- certain banking services to corporations. Q. But that experience in no way involved anything dealing with the foreign exchange market? A. That's correct. Q. Okay. Have you ever personally traded, yourself, options on -- foreign exchange options? A. I've not done a foreign exchange option. Q. I'm sorry. The answer -A. I've not done a foreign exchange option. I have done an option before. Q. Okay. But not a foreign exchange option? A. That's correct. Q. Are you familiar with the term "calculation agent"? Have you ever heard that term before? A. Yes. Q. And what is your understanding of the meaning of that term? A. Well, calculation agent is an institution or Page 5

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270116_1.TXT it's a party to an over-the-counter contract, and that party has the responsibility of making certain calculations, I guess. I'm trying not to use the same word, but... They're supposed to make the calculations that determine things like the market-to-market value of the contract or what the contract pays off at. On the ISDUB (phonetic) template that's used to fill out these contracts, there's a line that says calculation agent and it's blank and parties have to fill in a name for that and that becomes -- in some sense, I view it, it's a little bit like a referee. It's -- it may be one of the parties of the contract, it usually is, but it's someone who determines a number that is necessary to be used in the contract. Q. Did you see that term "calculation agent" used in any documents in this case? A. I believe it was. Q. Do you recall where? A. It probably would have been the confirmation, but I'm not absolutely sure. It is my understanding that Deutsche Bank is the calculation agent in this -in these cases. Q. What gave you that understanding? A. Well, I probably saw it. It's possible I heard it. To the best of my knowledge, you know, I probably saw it on a form, but... Q. Turn to Appendix C of your report, which is Exhibit 2400. And in your Appendix C you have a list of documents reviewed. Am I correct that this is the same set of documents you reviewed not only for your JBJZ report, but also for your Tesoro report in your -- I'll refer to it as your Murphy report? A. I'm not sure I can actually say that because I don't believe the list are identical, and I don't think there's a one-for-one mapping from one list to the other. I had certain responsibilities in this case and I needed certain things and I was given certain documents, but I know that some of these documents were not relevant to what I had to do. I'm not sure why I had them, but they weren't relevant to what I had to do. I needed the terms and conditions of the contracts, and I know I got that off of the confirmation. So the confirmation is primarily what I looked at. And I did look at a confirmation for each of the three. Now, you asked me -- I'm not trying to drift away from your question. You asked me if this is the same list. I believe if you look in all three Appendixes C, you would find that there may not be a one-to-one mapping on each of these documents. This document here matches up with a document in the other report that matches up to a document in another report. But I do have the confirmations in each of the three cases, and that's the principal information that I used. Q. How did you come to acquire the documents that are on Appendix C? A. Well, the law firm gave me the documents. Q. And how -- how did you come to get those specific documents? Did you request them or did they provide them to you? A. No, they provided me -- I did not request any Page 6

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270116_1.TXT specific documents. Q. And what did you do -- were all these -strike that question. Were these documents provided to you initially all at one time or did they come over a period of time? A. I'm not sure I remember exactly. I honestly don't know, but I know that I could not have gotten started on the case without the confirmations. I believe the confirmations came early, but, you know, I can't be certain. I just know that I wouldn't have gotten very far without the confirmations because that gave me the terms and conditions of the contract. I don't remember on each of these other documents exactly -- I know some of them came in later, but I know, as I said, that I did not use a lot of this information. My -- the scope of my responsibility, I think, was fairly limited. I know this is a big case and goes far beyond me. I know some of these documents, which are things like letters involving this transfer or that transfer, really didn't have any relevance to me. I'm not sure how I got them -- I mean, I know how I got them, but I'm not sure why I got them. Q. What did you feel the scope of your assignment was? A. The principal scope -- or the principal responsibility I had was coming up with probabilities for these options. There were several, I guess, secondary questions that are addressed in the report, such as: What was the value of the short option on the transfer day? Were the options in or out of the money on the day of the transaction, the transfer day, the termination day, and so forth? But my focus was really mostly on the probabilities of these options. Q. And when you say "probabilities," what do you mean? A. Probabilities that the options would be profitable. Q. Would be in the money, so to speak? A. Well, in the money -- you know, in the money for these options does translate into profitability, but for an ordinary option -- I'm hesitant to say that so generally because for an ordinary option in the money does not necessarily translate into profitability. It does in this particular case here. Q. Well, when I use the term "in the money," do you use that term also to mean the probability that the options would pay off? Is that what you're referring to? A. I'm assuming we're talking about this case? Q. Yes. A. And I want to be real careful because ordinarily when you're talking about a standard option, if you say in the money that does not equate necessarily to being profitable. It turns out in this case there are -- each of these options or these transactions, I should say, they have three outcomes and -- because there are two options and these three outcomes. In one of the outcomes both options Page 7

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270116_1.TXT expire out of the money, and you lose what you paid for the options. And then you have one where one is in the money and the other is out of money and -- I know this term "sweet spot" has popped up in this case, and that's what I'm talking about there. And then there's a third case where the Exchange rate is beyond both options and they -- and you end up having your long one short the other, you have a profit on one, you have a loss on the other, but you have a net profit overall. Q. And when you call that as having a net profit overall, how are you defining the term "profit"? A. Well, it would be that the payoff you receive when you exercise the option exceeds the cost you pay for the option. Q. And that's how you're defining it to be a profitable -A. Right. Q. -- transaction -A. Right. Q. -- am I correct? A. Right. Q. Okay. A. I interrupted. Q. Do you take into account in your analysis of profit other transaction costs? A. Are we talking about my original report or my rebuttal report? Q. Well, first let's talk about the original report. A. Okay. That's not taken into account in the original report. Q. Well, we'll come back to that entire area in more detail. But before we do, could you describe to us, first of all, when you were contacted by counsel to -- when was your first contact, approximately? A. I'm not sure I could put a date on that. I think we've been on this case -- I think I've been on this case about two years. I honestly couldn't tell you exactly. Q. And who was your first contact with? A. It was either Mr. Welty or Mark Thomas, and Mark is not with the firm anymore, and Joel Crouch who is still with the firm. I honestly couldn't tell you. I think Mr. Welty was the first person to contact me, but I know that I came and we had a meeting and I met all three of them. Ms. Wirskye was not involved at that time. Q. And at the point of the meeting were you told as to exactly what the scope of your assignment would be or did that come later? A. Yes, it was a -- kind of a general overview. In fact, we may have had some discussions on the phone. I know that he contacted me and said can you come to Dallas, and I said that would be easy to do. I'm only a one-hour plane ride from here. And we may have had some discussions on the phone to give me a little bit of light overview of it. But I know we had a meeting here in a room very similar to this, and he told me that, you know, there were these digital currency options. And that the issue that I would be involved in had to do with the probabilities of these options being Page 8

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270116_1.TXT profitable. And he would need me to opine or to analyze, I should say maybe first -- analyze these options, come up with some numbers, and opine about their probabilities of being profitable. Q. Other than that particular question, did he ask you to opine on other questions? A. Not at that time. I'm not sure what you mean necessarily by other questions. Q. Well -A. And he may have said at that time that there may be some other things that we'll need you to do, but, you know, that was kind of a minor detail. I don't really recall. I do know later he did subsequently ask me to do a few other things. Q. Did he explain to you at all any of the documents that the parties had obtained from third parties, including the Deutsche Bank in this litigation? A. Well, I'm not sure if I would remember that, but I know I've done a few of these cases and I know that it would -- I would have expected that there would have been documents. There wouldn't be any way I could analyze this without some documents. And whether we had a discussion about the documents or not, I don't recall. But it would have been obvious to me that they would have had to have documents, in particular the confirmation. I would need to see the terms of the contract. And, you know, I may well have said to him I'll need to see the terms of the contract. You know, he probably said well, yeah, we can get that. Q. What about any internal documents from the Deutsche Bank, did -- were you aware as to whether or not any of those documents had been obtained? A. I honestly don't know. I mean, you're asking me to remember a conversation a couple of years ago. I just have to say I don't know. Q. After you had a chance to review the documents you did receive, did you make a request, for example, for additional documents that would assist you in connection with your work? A. I don't think I did because I think that the confirmations were the primary documents that I used. In order to calculate probability I felt like I would need to know the terms of the contract. I did eventually see some other documents. As you see, there's a list there with a lot of documents and all. And I read over them, but I don't recall if I requested anything else. I know that the -- I just don't recall using anything else much except for the confirmations. Q. Did you ask counsel if, for example, the Deutsche Bank's pricing data was available? A. I probably did, but I don't recall for sure. I mean, I just can't say for sure. Q. As you review the documents on your list, do you see any documents that reflect what the Deutsche Bank's pricing data was? A. Well, there's some Deutsche Bank documents here. I don't know if any of these reflect their pricing data. Q. I'm going to hand you what's been marked as Page 9

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270116_1.TXT Exhibits 2806, 2807, and 2808. Do any of these documents look familiar? A. The first one does. The second one looks strange -- strangely unfamiliar because of the typeset is so large. I just -- I don't remember seeing the second one. And the third one -- I'm not sure about the third one. I know the first one does look familiar. Q. And do you know why? Is that on your list? A. I'm not sure. They keep track of the documents that are sent. If it's on the list, it's on the list, but I don't remember. Q. Do you know -A. I just remember it looks like something I saw. Q. Do you know what that document is? A. Well, it looks like a bank document. It's called an owe debt -- option deal entry ticket or whatever the "T" stands for. And it's some sort of a document that the bank takes when it does a transaction and it goes through the bank's accounting system and, you know, it's in effect something that's in the bank's internal system. Q. But are you just speak- -- guessing now or do you know as a fact what this document is? A. Well, I can look at the document and I can see things that I can interpret and say -- first of all, I see the word "option deal entry," and so I think, well, that's probably the bank's document. I'm pretty sure that's the bank's document. Q. But you're now guessing, right? See, I want your personal knowledge. You believe you've seen this document before, and what I want now is your personal knowledge of what this document is. And your personal knowledge could have been acquired from your review of other documents. But do you have any personal knowledge of what this document is? A. I'm still unclear about your question. Now, if you hand me a document like this and I can look at the words that are down the left column and I can look at the words down the right column, this looks to me like a bank document that says that a transaction was done on a certain day, and there were certain terms in that transaction. It has a certain expiration day. And there's entries here that sort of refer to things that the bank may have done. Currency premium is paid in U.S. dollars, et cetera, et cetera. So I'm giving you an interpretation of what I see in this document based on my experience. Q. As you sit here today, correct? MS. WIRSKYE: Objection. Form. A. As opposed to what? Q. (BY MR. DONOHUE) Well, as opposed to a document, for example, that you had used in connection with your work? A. Well, I did not use the bank documents to make my calculations. As I said, this does look like something that I remember seeing. Q. If you, for example, had this document at the time you were doing your analysis, do you know whether or not you would have used it? A. Not necessarily. Q. And why not? Page 10

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270116_1.TXT A. Well, a couple of reasons. One, I felt it was fairly important that I try to work as independently of the bank as I could. If I just mimic what the bank does and come up with the exact same thing the bank does, I'm not sure that you need an expert witness to do that. And I tried to work independently. And I took the information off the confirmations and I tried to make the most independent and unbiased assessment as I possibly could. Now, I vaguely recall -- I know that's a rather murky term -- but I vaguely recall in looking over these numbers and wondering about some of them like -- and, again, I can't remember exactly what this was, but some of the numbers like the amount -- it seems to me that the amount they were doing in the form of a hedge, they didn't look right. And I started having questions about some of these numbers. How could they have come up with some of the numbers they did. I said, well, I'm actually going to try to work independent of the bank anyway. So basically I didn't use their sheets. Q. See, I'm a little confused. Take a look at -on Exhibit 2806 what is known as a Bates -A. Wait a minute. Where's the number? Oh, I see. Q. Take a look at the Bates Stamp number at the very bottom. Do you see that number DB COBRA 04211, do you see that? A. Yes. Q. Now, take a look at your Appendix C of the documents that you reviewed. I don't see any Bates Stamped numbers with a DB COBRA on it. Am I correct? A. I guess. I haven't looked over it, but... Q. Well, if you just take a look at -A. Well, I mean, I believe you. Q. Wait until I finish. Take a look at the beginning and ending documents. The documents you were supplied -- and I notice all have a Z zero on it, and they -- on the second page, you have a page and a half of documents. I don't see any DB COBRA documents. Am I correct? A. That's the way it looks. Q. So is it fair to say that this is not a document that you have at least included in the documents that you reviewed in Appendix C? MS. WIRSKYE: Objection. Form. THE WITNESS: I answer, right? MS. WIRSKYE: Yes. A. The list of documents that is on here was provided to me by the law firm, and I made the assumption that the list was correct. As I said, I only really used the confirmations. But it's my understanding they keep track of the list of documents that are sent to me, and all I can tell you right now is this looks familiar. Q. (BY MR. DONOHUE) But you can't -A. If it's not on the list, it's because it was not on the list that was sent to me. Q. Okay. But if it looks familiar and it's not on the list, is it because the list is wrong or because you were shown this at some point after you did your report? Page 11

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270116_1.TXT MS. WIRSKYE: Objection. Form. A. Oh, no, I definitely -- if I did see it -- and as I said, it looked familiar -- it was definitely before the report because the report was only done a few months ago. Q. (BY MR. DONOHUE) Okay. All right. So even though it looks familiar, it's not a document that appears to be on your list. So is it fair to say that even though it looks familiar, you did not even use this document in connection with your report -MS. WIRSKYE: Objection. Q. (BY MR. DONOHUE) -- in preparation of your report? MS. WIRSKYE: Objection. Form. A. As I said, I did not use this document in preparing my report. Q. (BY MR. DONOHUE) Okay. All right. Now take a look on Exhibit 2806 at the second to last row, do you see that term on the first page -A. Are you on the -Q. The first page. A. Yeah. Q. Do you see that term "Volatility to Expiry"? A. Yes. Q. Do you see that? Do you know what that means? A. Well, that's their opinion. Whoever entered this, that's this person's opinion of the bid and the ask volatility over the horizon of the transaction. Q. And when you say "this person," are you referring to, for example, that's the Deutsche Bank's? A. Well, some human being had to put -Q. Right. A. -- these numbers in here, so... Q. So -A. Now, when I said this -- excuse me. When I said this was Deutsche Bank's before -- and I don't see Deutsche Bank's name on it -- I'm drawing the conclusion that it's Deutsche Bank because it says option deal entry. Q. Well, isn't it there right up at the top? A. Oh, that's right. It's very small. Q. Now, if -- you're saying this is a reference to a bid and ask volatility, am I correct? A. Yes. Q. Had you had that information at the time you did your report, is there something you may have used that information for in doing your analysis? A. I'm not sure I follow that question. You said is there something -- might I have used that information when I did my analysis? Q. Right. A. I don't think so. As I said, I tried to -- I tried to be as independent of the bank as I possibly could, and I don't believe that if I had just taken the numbers off of the bank's numbers, I would have been acting independent. I know where you're actually heading with this on volatility. And I'm sure we'll have an extensive discussion about that before this is over. Page 12

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270116_1.TXT But first of all, to sort of back things up, whenever it was that I saw this was indeed before the report, so I did have the option -- no pun intended -- to use this. Q. I'm sorry? Say -- I missed what you just said. A. As I indicated, I did the report a few months ago. And as I said, I believe I recall seeing this and it was definitely more -- or earlier than that point in time. So I suppose I would have had the option to do this. So if I would have done it -- I'm just not quite sure of the wording of your question. You're saying would you have used it. But I did have the option to use it, and I chose not to use it. Q. Well, I'm totally confused. Because we've just established that this document is not a document that is on your Appendix C of documents you considered, correct? A. It's not on Appendix C, but I'm telling you that I have seen the document, at least it looks familiar. Now, what -- how it got left off of Appendix C, I don't know. Q. Well, is that the only document that -- in other words, you understand that you have an obligation as part of the Federal Rules of Civil Procedure to list the documents in which you reviewed and considered in connection with this assignment, do you understand that? MS. WIRSKYE: Objection. Form. A. I asked them for the list of documents they have sent me, and this is the list they sent me. Now, I did make the assumption -- I didn't check each individual document. I made the assumption that these lined up with the documents that I received. Q. (BY MR. DONOHUE) What I -A. I did feel confident that the documents I used were on the list. Q. Well, since you are saying that you may have seen this document and yet it's not on your list, I'm going to make a request that after the deposition is over that you review the documents that you have to make sure that your list, Appendix C, is complete and accurate. And if you have documents that you reviewed that are not on this list, then I'm going to ask that you revise Appendix C to provide us what is an accurate list of the documents you've seen. A. Sure. Q. Do you understand that? A. Yes, that's fine. Q. Because the obligation to provide the list is not counsel's obligation. It's the witness's obligation. A. That's correct, yes. Q. All right. Now, let me hand you what's been marked as Exhibit 2415 and 2422. A. Do I hand these back? Q. No, you keep them. We'll come back to those. MS. WIRSKYE: And Dennis, are you giving him the court reporter's copy? Is that... MR. DONOHUE: That's the procedure. MS. WIRSKYE: Okay. I just wanted to make sure. Q. (BY MR. DONOHUE) Twenty-four -- Exhibits 2415 Page 13

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270116_1.TXT and 2422 they should be Dr. DeRosa's, who is the Government's expert witness in this case, opening and rebuttal reports. Have you had an occasion to read those reports? A. Yes, I have. Q. And I'm going to also give you what's been marked as Exhibits 2429 and 2434. MR. DONOHUE: I have the wrong number here, okay. Let me for the record point out that 2422 is not Dr. DeRosa's rebuttal report, so I'll get that in a second. MS. WIRSKYE: Dennis, can we stop for just a second here. I think we've got some reports from some other cases that you've given me. THE WITNESS: This says Ira Shepard. MR. DONOHUE: Okay. Let's see, then -okay. Let's see what we have here. Yeah, it's the wrong exhibit numbers, sorry. Q. (BY MR. DONOHUE) Well, let me ask you without actually giving you reports because I don't think necessarily you need the reports. Did you read the reports of Dr. DeRosa and Dr. Kolbe, both their opening and rebuttal reports? A. I did, but let me qualify I didn't read each of the three cases word for word. Q. You read, what, just one report in each case? A. I read one and then I sort of skimmed over the others and looked for, sort of, where they diverged. Q. Now, as a result of reading their reports, did you see any reason to change any of your opinions or modify any of your opinions? A. No. Q. Let's take a look at your reports, and go to Exhibit 2400. And I'm going to give you what's been marked as 2402 and 2404. Now, first let's go to 2402. Is that your report in the Murphy case? A. Yes. Q. And go to Exhibit 2404, is that your report in the Tesoro case? A. Yes. Q. And am I right that the analysis and the ultimate conclusions in your reports in these cases are essentially the same? A. Well, you know, the numbers are a little different, but I think -Q. The numbers are different, but the analysis is -A. -- generally, yes. Q. And ultimately your conclusions are the same, are they not, in all three reports? A. Yes. Q. And with that in mind, even though I'm entitled to ask you questions on each separate report, we can speed this along. What I plan to do is take two of your reports, the JBJZ report and the Murphy report and go through some in-depth questions with respect to those reports. But to the extent that you would feel that there would be some difference in your answers with respect to my questions, I'm going to ask you to alert me. If I don't feel on your part that -- or hear on Page 14

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270116_1.TXT your part that there is a reason to be different, I'm going to assume that your answers would be the same for the Tesoro or for the other report -- the other report that I'm not immediately referring to. Is that clear? A. I understand, yes. Q. All right. Now, prior to -- and let's start with Exhibit 2400. Do you know approximately when you finished writing the report? A. It was sometime in the spring. I don't know if I could tell you exactly. The report has a date of May the 8th. I seem to recall it was due the 31st or something like that, but I went on vacation for the last two and a half weeks of May. So I finished it a little bit early, that's why the date doesn't line up with the deadline. I would have to say it was probably early May, possibly April. But when I write something -- I mean, I've written many articles in books and I can say I've finished, but finishing means sometimes putting it aside -- I like to put things aside for maybe sometimes a few weeks and let my brain sort of clear out and go back to it. And I probably did that. So I may have actually had the draft done a while back, before May the 8th. Q. And did you submit the draft to counsel for counsel's review? A. What do you mean by "submit"? Q. Give it. A. I mean, we had discussions. No, I don't think I did that. Q. You didn't -A. We had discussions about it certainly. Q. Well, but you gave a draft to counsel in order for counsel to read it, am I correct? A. It depends what you mean by draft. I don't think they read anything until the final report, but I don't recall. I mean, I know we had discussions about it. Q. As a result of those discussions, did you change any portion of your report? A. Well, I may have, but I don't know. If what you're getting at did counsel tell me to say something, no, it's not what happened. Q. Sir -A. We had discussion about it and I'm sure I made changes. Even if we hadn't had discussions, I would have made changes. Q. All right. Let me go to your comment "getting at." Whatever I'm getting at is the basis -- is my question. So that's the sum and substance of what I'm getting at is whatever question I ask you. Is that clear? A. I'm not sure if it's clear, but I think you can proceed. Q. Okay. Now, that's why I'm a little confused. If you gave to counsel the report and then there were changes, why wouldn't that -- why wouldn't you consider that to be a draft report? Isn't your final report at the point that all changes were finished? Isn't that what you consider your final report? MS. WIRSKYE: Objection. Form. Page 15

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270116_1.TXT A. I'm still confused. I did not E-mail or Fed Ex counsel a -- this until the very end. And we had discussions about this. And as I recall we had meetings that were online where they saw my words, were able to see the words that I had, but I did not send them a report. Q. (BY MR. DONOHUE) Oh, I see. A. I didn't E-mail them or Fed Ex, or whatever you call it, until -- I don't want to say May the 8th, but somewhere around May the 8th, I suppose. Q. And when you say online, did you have, for example, or did they have, for example, a site you could go to or did you have a site -A. They had the -- there's the ability to see things online, to look at what's on the screen. Q. And whose -- when you say there is this service. Whose service is it? A. I'm not sure. It's just the Internet. I mean... Q. Right. But did they inform you or did you tell them, I'm going to put my report on -- online? A. By the way, let me not say online. It's not like anybody could get it -Q. Right, I understand. A. -- you know, so let's be careful about that. But they have -- there is the ability to look at the report. I think it's called Net Meeting or something like that. We can actually look at something on someone else's computer, and we had discussions about it. Q. Okay. And how many times did this occur where you put your report online and there were discussions? A. I don't remember. I don't remember. It wasn't very many. Q. More than five? A. Oh, I'm pretty sure it wasn't that many. Q. So it was less than five? A. You know, I'm pretty sure, but I can't swear. Q. And then you -- then you had discussions, what, by telephone regarding the report? A. Yes. Q. And do you recall as you sit here today as to what some of those discussions were about? A. Well, you know, we discussed a lot of things. Any attorney is going to have discussions with their expert witnesses. I'm not sure I can remember exactly what we discussed. But I know that under no circumstances did they ever tell me what to say. Q. Sir, you understand you're under oath. A. I know, yeah. Q. And if you do remember something but you say you don't, you understand that is a violation of your oath. Do you understand that? A. I know, but I don't -Q. Did you understand that? A. I can't remember the details. I do understand -Q. Did you understand the question? A. -- your question -- your point, I mean... Q. Now my questions is, you mentioned you had a number of meetings, and all I'm asking you is do you recall anything from those meetings as to what was Page 16

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270116_1.TXT 0038 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0039 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0040 1 2 3 4 5 6 7 8 9 10 discussed? MS. WIRSKYE: Objection. Form. A. Well, they read -- you know, they read parts of the document, and they might ask me or make a comment about it or say something is unclear as if someone is trying to read something that you've written and trying to understand it. And I honestly can't recall. I mean, I've written books and articles and gone over them and over them many times, and I couldn't recall what I -you know, what preliminary thoughts I might have had when I re-read something. So I don't know exactly what it was that we might have discussed because it's a, what is it, a 60-page report or so. Q. (BY MR. DONOHUE) So it's your testimony under oath that in all the meetings that you had nothing comes back to you as to any specific discussion about what you had? Is that your testimony under oath? MS. WIRSKYE: Objection. Form. A. If you're -- you're asking me to -- are you asking me to point out a specific paragraph or something like that, I mean... Q. (BY MR. DONOHUE) I'm asking you whatever you remember. Not necessarily with respect to a change, but the discussion. I'm asking you -A. It's just -- it's just a pretty hard -Q. Let me finish my question. A. Okay. I'm sorry. You're right. Q. Let me finish my question. A. I thought you were through. Q. Do you recall anything about any of the specific discussions you had when you were discussing your report with counsel? A. I don't recall at the moment. If I had some time and thought really, really deeply and went through the report line by line, it's possible something might come back to me. But I don't recall at the moment any specifics. Q. As a result of those discussions, did you change your report in any way? A. I made editorial changes to the report certainly. Q. And what do you mean by "editorial changes"? A. A certain sentence might be worded a certain way, I might word it a different way. I'm always open to someone telling me that something isn't clear. Q. Look at Exhibit 2400, that's your JBJZ report, page 18. Am I correct that you use the Black-Scholes model to calculate the values of the short option? A. That is correct. Q. Take a look at page 39 of your report, Exhibit 2400. Am I correct that you determined the theoretical values of the options on the date of their contribution to the partnerships? A. Yes. Q. And take a look at page 17 of your report. A. Yes. Q. Am I correct that you point out that volatility is probably the most important factor in valuing options? A. That's correct. Page 17

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270116_1.TXT Q. How do dealers determine volatility? A. Well, that's the universal question in options and is the one piece of information at which people would have a great deal of disagreement about. No one really knows exactly how they determine volatility. I'm pretty familiar with the 30-year literature on research on volatility. There are a couple of methods, implied volatilities is one and historical volatilities is the other. One could even blend them for that matter and one could even make an opinion -- a wild guess is what I'm trying to say. One should also keep in mind that whatever volatility number you put into a model, is a number that picks up a lot of factors that the model might not be picking up. For example, one of those pages you had me look at, there was a bid and an ask volatility. Well, the stock only has one volatility, or an option, a currency, I'm sorry. It has only one volatility, and yet on one of those pages there's two volatilities. Well, that's because one of those numbers has been used to quote a bid price and one is being quoted -- or one is being used to quote an ask price. So the volatility number subsumes a lot of information. And dealers have to think about what they think is a good guess as to what the volatility is. Q. So if I understand your answer, you don't know how a dealer determines volatility? A. Well, what I'm trying to say is that there is no universal method of determining volatility. It is an opinion, and dealers don't tell you how they determine volatility. In fact, determining volatility is the whole -- it's kind of the whole nature of the options game. Whoever is coming up with the best number will do the best. If I knew how to determine volatility with absolute certainty, I would make a lot of money and I wouldn't tell anybody. Q. Well, did you understand the question I asked you? A. You asked me how dealers determine volatility. Q. Yeah, but I asked you do you know how dealers determine volatility. What is the answer to my question? A. I have an idea and I've given you the idea. They -- as I said, I think they look at historical volatility. They look elsewhere in the market. And they also pad those numbers with all these other effects that are not being captured by the model. Q. And what's the basis of your opinion? A. Twenty-five years of observing these markets, doing research, reading articles. I talk a lot to practitioners. I attend practitioner conferences. I read a lot of practitioner publications. I can only say that I've obtained that since -- from my experience as an observer of this market. Q. Do you know how Deutsche Bank arrived at their volatility numbers? A. Well, I wouldn't know in a specific case. The previous question I interpreted as being sort of a general question, and I wouldn't know in a specific case. Although I would think it would have something to do with what I previously said. Page 18

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270116_1.TXT Q. And I showed you Exhibit 2406 which had the -do you want to take a look at that again? It looks like this (indicating). A. Right. Q. I showed you this Exhibit 2406. Do you happen to know, for example, what this transaction, which is Exhibit 2806, refers to? A. Well, it's a transaction involving Euro. It looks like it was started on the 23rd of November to terminate on the 22nd of December. Someone named Brooks sold it. There's some other numbers here. With a little more time if I were to read every single number, I might be able to nail it down. Q. Take a look on the second page of the document, the second to last row, confirmation details. A. Yeah. Q. Do you see a name there that may be familiar? A. Yeah, JZ Buckingham looks familiar, sure. Q. Now, if you turn to the third page of the document -- which is something that says leg one -you'll see, for example, information about three-quarters of the way down regarding the customer premium amount. Do you see $20 million? A. I'm still looking for leg one, I'm sorry. Q. It's on the third page of the document. It's Bates Stamp No. 04213. It's the third page -A. I see that, but I still don't see your leg one. Q. Oh, leg one is the second -A. Oh, I see, the second line. Q. -- the second line. A. The second line, all right. I'm with you. And go back to what your question was. Q. If you go to -- for example, three-quarters of the way down you'll see something called customer premium amount, $20 million. Do you see that? A. Yes. Q. And, for example, if you go over to leg 2 which is that Bates Stamp No. 04215. A. Yes. Q. Do you see a customer premium amount there of $19 million? A. Yes. Q. Does that look at all familiar or sound familiar with respect to one of the pairs of option for the JBJZ? A. Well, I can only say it looks familiar, but I don't have the numbers memorized of all these options. Q. All right. But am I correct that even if you -- even if you had seen this information at the time you were doing your analysis, you would not have used that document in any way in doing your own analysis? MS. WIRSKYE: Objection. Form. A. Well, the operative word is "would." I felt comfortable doing my own independent analysis. I think if I had seen a number on here that may be contradicted. I would have felt probably even more right about not using this. And as I said, I tried to do my analysis as independently of the bank as I possibly could. And so I didn't use these numbers, no. Page 19

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270116_1.TXT Q. (BY MR. DONOHUE) When you -A. I did an independent analysis. Q. When you say that if you had seen a number on here that may have contradicted, I would have felt probably more right about not using this. I'm not clear as to what you mean by that. What do you mean by that? A. Well, like a mistake. I mean, this is -- this is 24 -- 2806. This 2806 is a sheet that some human being obviously has to enter this information into the system. I think we talked about that earlier. And if I had seen some number like maybe the date wrong or the strike rate wrong or the strike rate didn't line up with the premium and it looked like something was mixed up in some way, then I definitely would not have wanted to use it. Q. You used, am I correct, historical volatilities? A. That's correct. Q. And your historical volatilities, am I correct, were based on time periods of 30, 60, and 90 days? A. That's correct. Q. You mentioned the term "implied volatility." What is implied volatility? A. Well, let's back up just a little bit. An option model has either five or six variables in it. In the case of currency options, you're going to have six. You will see by the way -- if you look in a book, you'll often see a set of five. But oftentimes they leave the payout out of the initial explanation. But it has six variables, and the volatility is one of those variables. And that volatility is a number that represents someone's opinion about what the underlying volatility or variation, or whatever you might want to call it for an alternative word, will be. It is a number where there could be potentially a great deal of disagreement. We could disagree somewhat on interest rates. We could disagree a little bit on what the value of the underlying is depending on the timing. We wouldn't disagree on the expirations of the exercise prices. So volatility is the number where there is potentially the most disagreement. And it's an important number, as you pointed out in one of my statements there, it's a very important number because it is a number that doesn't reveal itself to us very easily. Q. Okay. But my question is: What is implied volatility? A. I did get -- I got distracted I'm sorry. I felt like I needed to cast it into an appropriate setting, what are the numbers. Implied volatility is to go to the options market, take the price of the option, and to back out the volatility that the person who traded that option put into the model to get that price. So it is a number that is -- you can infer from the price of the option. There's a procedure for solving the option formula to get the volatility out of it, and that gives you an idea of what that person's opinion is of Page 20

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270116_1.TXT the volatility at the time he said I will do this transaction at this price. Q. Now, in order to make that determination, am I correct that you would need to know the price of the option? A. You would, yes. Q. Okay. A. You also have to know a model. I mean, you would have to agree on a model. Q. Did you make any attempt to determine implied volatilities based on the prices of the options that you saw in the confirmations? A. In other words, if this option traded at this price, this was the implied volatility? Q. Yes. A. No, I didn't do that. Q. Is there some reason you did not do that? A. Well, first of all, I decided for a number of reasons -- and we can get into that now or later if you want -- that I wanted to use the historical volatility. I know that there is no right or wrong answer for what volatility is. There's no magic number that some one of us is going to be able to stand up and say, I have the number. I know what is the correct volatility. And I also wanted to give a range of numbers because I know that, as I said, there's margin of error on what everybody does. We don't know what the volatility is. I wanted to give a range of numbers, and so I felt it was important to look at the recent history of the market. One of the problems you have with using implied volatility is that in the Exchange listed market, option trading is very transparent and the extensive studies that have looked at implied volatility have all looked at the Exchange listed market. To my knowledge there are no studies that look at the over-the-counter market where there's considerably less transparency. If I might elaborate a little bit, I don't know if everybody understands the word "transparency." Would you like to elaborate a little bit on what that means? Q. Sure. A. It's an esoteric term that's used a lot in this profession. If you and I were option traders on the floor of the Chicago Board Options Exchange -- and by the way, you can trade electronically when you're not on the floor -- but if we were on the floor and I were facing you and I called out a bid for an option and you hit the bid -- just another term they use to say you agreed with me and we just did a transaction -- well, that transaction goes through a system. We do some paperwork and so forth. It goes through a system. It goes into the Exchange, and it gets recorded. And tomorrow when the Exchange reports the volume of trading, that transaction will say we've made a mistake. It's going to be in there. And that transaction goes into a database. And those databases are accumulated over periods of many years and they end up in the hands of academics oftentimes, like me, who do studies about Page 21

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270116_1.TXT implied volatility. And there have been 30 years or so of studies of implied volatility. But to my knowledge they've all been on the Exchange listed market. Now, every study on implied volatility have not supported implied volatility as a very good predictor, future volatility. One study in particular said it was a pretty bad predictor. But most of the studies say that it's a pretty good predictor. But the problem is it's in a very transparent market, like the Exchange listed market, where all the transactions are collected and recorded and they go into a big database. In the over-the-counter market if you and I did an over-the-counter transaction -- we could do one right now I suppose if we weren't in the middle of a deposition -- I could say I'm going to buy an option from you and you're going to sell that option to me. There's no one out there collecting this information and recording it and also recording the transactions that maybe you guys did at the same time. And to my knowledge there's never been any studies that have looked at a fairly nontransparent market like the OTC market. That implied volatility is a better predictor. Now, I'm not saying -- I'm not here to actually say that it's a worse predictor. I'm saying we really don't know. And for that reason I felt it best to try to come up with multiple estimates and to use recent historical data, and that's basically my justification for doing it. I don't want to just copy what Deutsche Bank has or to try to figure out the implied volatility because Deutsche Bank built into the price of these options a profit margin. And I'm not sure that profit margin would be a very good number for me to stick into the model and come up with implied volatility and that would buy us the forecast. Q. Dr. Chance, if you did do a determination of the implied volatility, these options, based on their option price and you arrived at volatilities that were or at least seemed suspect, what would that tell you about the price? MS. WIRSKYE: Objection. Form. A. Let me see if I've got your question right. If I calculated some implied volatilities and maybe they looked really out of line or something -Q. (BY MR. DONOHUE) Correct. A. -- or they were too big or something like that, are you -- is that a general question or are you referring specifically to these options? Q. I'm referring specifically to these options. A. Well, I think that's probably almost surely what would happen because of the prices of these options. They had a profit margin built into them. And so yeah, I mean, I would be suspicious of these numbers. Q. You say because they had a profit margin built into them? A. Sure. The banks -- banks build profit margins into them. And also -- they also build bid and ask. Somewhere on one of these exhibits you previously showed me was a bid volatility and an ask volatility. Q. Do -A. That's something of a profit margin right there. Page 22

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Document 156-3

Filed 03/07/2008

Page 41 of 158

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270116_1.TXT Q. Well, let me just take that statement. You're aware that there was not only a long option that was purchased by one of the entities, but there was also a short option that was purchased by the Deutsche Bank? A. Right. Q. You're aware of that? A. Sorry, yes. Q. And you're aware, I assume also, that banks normally do not overpay for their options? MS. WIRSKYE: Objection. Form. A. I suppose they don't. Q. (BY MR. DONOHUE) So what if on the short option you made a determination as to what the implied volatility was and you determined that, in fact, you have a number, which is out of line, totally inconsistent with what you would think would be a normal range for volatilities, what would that tell you? A. Well, I'm not sure what it would tell me other than there was something wrong with the numbers or that the implied volatility contains something in there that's not really the volatility. I think if you go back up a few pages or whatever, you'll note that I pointed out that volatilities -- I didn't use this word -- but the word is subsumes. It subsumes within it a lot that the model is not capturing. So it wouldn't necessarily surprise me if I calculated implied volatility and it looked like it was somewhat off from what I thought the volatility was. It wouldn't surprise me at all because that number subsumes within it a lot of other information. Q. Do you recall, for example, in the Murphy case there were options that were based on the Euro dollar conversion rate? A. It's not Euro dollar. Q. I'm sorry, the Euro. A. Euro. Euro dollar is something totally different. Q. Yes, yes. I understand what Euro dollar is. I did a case on it. Euro -A. Yes, there were Euros I believe in that case. Q. What if, for example, you found that the implied volatility for those options was over 100 percent, does that sound like a reasonable volatility? MS. WIRSKYE: Objection. Form. A. Well, not necessarily and let me explain. If you consider that the implied volatility assumes within it a lot of other information, 100 percent would certainly strike one as being big, but it depends on what you mean. If it subsumes within it the bank's cost and the bank's profit margins, I don't know whether it would be big or not. But if I'm supposed to take that number, 100 percent, and say that is the bank's prediction of the future volatility of something like a currency, contrast to maybe some Internet company or something, then yeah. But I wouldn't take that number for that purpose. I wouldn't use that number for that purpose. Q. (BY MR. DONOHUE) Could it possibly also indicate that the price of the option, in fact, is considerably overstated? Could it indicate that? Page 23

gov.app.96

Case 1:05-cv-00231-EJD

Document 156-3

Filed 03/07/2008

Page 42 of 158

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MS. WIRSKYE:

270116_1.TXT Objection. Form.

A. Well, anytime you have an over-the-counter market your option price is not going to precisely equal the model price. And I sort of object to your word "considerably" because that's such a -- what one might call considerably, another one might not. If you say it -- if you just said overstated, I think I could go along with that. But I don't know exactly what considerably means in that context. Q. (BY MR. DONOHUE) All right. You don't believe that market volatility is a more accurate gauge of volatility than historical volatility, am I correct? MS. WIRSKYE: Objection. Form. A. I believe you may have said the question wrong. I'm not sure why I should be helping you, but I think you meant to say implied volatility. You said market volatility. Q. (BY MR. DONOHUE) Well, what do you consider market volatility to mean? A. Well, that word could mean a lot of things. What is -- what is market -- if someone said what is market volatility, I would interpret that to mean that -- are you talking about what's the standard deviation as of today? I mean, it could really mean a lot of things. I think you would have to be a little clearer on that. Q. When dealers, for example, determine volatility, does their determinations change day by day? MS. WIRSKYE: Objection. Form. A. Well, it certainly could. Volatility changes a lot. We've all seen a huge amount of volatility in the stock market, and then we saw it calm down. So it could very easily change not only on a day-to-day basis, it could change within a day very easily. Q. (BY MR. DONOHUE) Do you -A. Can I finish here? I'm sorry. Q. No, go ahead. A. I know I sounded like I'm finished. But what I wanted to add was: Information is constantly hitting the market, and that information makes people assess where markets are going and how much volatility is in it. So for that volatility number not to change consistently over a long period of time, I mean, that would be really unusual. Q. Are there outside services that have information on volatility, for example, Bloomberg? A. Yes. Q. What does Bloomber