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Strictly Private and Confidential

Strictly Private and Confidential. Managing Banking Relations in a Transparent World RBC Capital Markets – Global Investment Solutions. October 28, 2013 Scott McBurney & Cindy Hansen - RBC Capital Market Patrick J. Hickey & Joseph Sardo - RBC Dominion Securities

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Strictly Private and Confidential

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  1. Strictly Private and Confidential Managing Banking Relations in a Transparent WorldRBC Capital Markets – Global Investment Solutions October 28, 2013 Scott McBurney & Cindy Hansen - RBC Capital Market Patrick J. Hickey & Joseph Sardo - RBC Dominion Securities patrick.hickey@rbc.com Phone 905 546 5677 www.joe.sardo.com

  2. Structured Notes – A Primer PPNs Option-based NPPNs Long Equity NPPNs Ground-breaking New Product “Tactical Equity Allocation Model” Security RBC Structured Notes Outline

  3. Structured Notes – A Primer

  4. What are structured notes? SNs are senior unsecured debt obligations of RBC Rank equally with RBC deposit obligations No CDIC insurance Pay-off at maturity linked to the change in the price of a market asset Market assets can include Equities, commodities, currencies, interest rates SNs may or may not pay coupons Two main types Principal protected notes (PPNs) Principal guaranteed to be repaid at maturity Non principal protected notes (NPPNs) Principal not guaranteed to be repaid at maturity Designed to be attractive alternatives to traditional equity investments Structured Notes – A Primer 3

  5. What are structured notes? SNs are very flexible investment vehicles Represent a powerful “tool kit” for investors Can be created to reflect a specific investment view of a client Virtually all aspects of a SN can be customized Term Level of principal protection Underlying market asset and currency Upside participation IA compensation Structured Notes – A Primer 4

  6. Structured Notes – A Primer What makes a “good” structured note? Purpose Should have an investment premise or purpose Should represent a strategy that the client cannot replicate cost effectively on his / her own Simple and transparent Should be easy for the client to understand It should be easy to calculate, for various outcomes What the coupon payments (if any) will be What the payment at maturity will be The simplest notes are generally “passive” strategies linked to public market assets Low cost The total cost of a SN (selling commissions, issue costs and hedging costs) should be reasonable Control over these costs is critical to ensure that a SN represents an attractive investment RBC will be transparent about its profit and will control the total cost embedded in its SNs 5

  7. Principal Protected Notes (PPNs) Economically, PPNs consist of A “zero-coupon” bond One or more financial “options” (equity, commodity, FX etc.) Current low interest rate levels make the embedded zero-coupon bond expensive PPNs have become more complex to Cheapen the embedded options Improve deal pricing and terms Investors must examine PPN structures carefully to make sure they fully understand them It is easy to be misled about how a PPN will perform Structured Notes – A Primer 6

  8. Non Principal Protected Notes (NPPNs) The general features of NPPNs Intentionally, not principal protected Designed to be attractive alternatives to traditional equity investments such as Stocks, ETFs, mutual funds, closed-end funds and hedge funds Have the same downside risk as a traditional equities Sometimes less risk (“buffered” principal protection) There two main types of NPPNs “Option-based” NPPNs Allow you to customize the payoff profile of an equity investment Have some option-like characteristics Dividends invested in structure – not paid out “Long Equity” NPPNs Enable very efficient access to compelling high turnover “long” equity strategies Have no “optionality” Structured Notes – A Primer

  9. Principal Protected Notes (PPNs)

  10. Principal Protected Notes (PPNs) Enhanced Yield PPNs Sample Calculation of an Annual Coupon • Investment objective: Clients are conservative, seeking the potential for annual income in excess of GIC's or government bond yields. Principal protection is paramount. • Product Pay-Off on Sample Terms: • Annual coupon of 0.00% - 7.25% based on the performance of a portfolio measured annually from inception where each asset with positive performance is counted as 7.25% and each asset with a flat or negative return is recorded as its actual return. • There is a floor on negative returns per asset of -25%. • Full principal return at maturity. • Can also offer fixed coupons in year 1 or minimum coupons per annum • Risk: Opportunity cost, typically the yield on government bonds over the investment term. • Daily liquidity provided by RBC • This pay-off profile is possible on the following assets: ETF's, shares, and commodities • Commentary: This product is constructed using options. The pricing, or the terms we can provide to investors improves with increasing interest rates. This strategy should appeal to investors who are seeking market participation without risk to principal. Sample Terms: • 5 year term • Linked to portfolio of Canadian equities • CAD / currency hedge possible on foreign denominated assets • Annual coupon of 0.00% - 7.25% based on portfolio performance

  11. Principal Protected Notes (PPNs) Individually Capped PPNs • Investment objective: Clients are conservative and seek diversification through returns linked to commodity markets. Principal protection is paramount. • Product Pay-Off on Sample Terms: • 100% of the return in a portfolio of assets, subject to a maximum return for each asset of 50% and therefore a maximum return for the portfolio of 50%. • Return cannot be negative • Full principal return at maturity. • Risk: Opportunity cost, typically the yield on government bonds over the investment term. • Daily liquidity provided by RBC • This pay-off profile is possible on the following assets: equity indices, equity sub-indices, shares, ETF's and commodities • Commentary: This product is constructed using options. The pricing, or the terms we can provide to investors improves with increasing interest rates. This strategy should appeal to investors who are seeking market participation without risk to principal. Sample Terms: • 5 year term • Linked to silver, nickel, corn, sugar, natural gas, crude • USD / currency hedge possible on foreign denominated assets • Return capped at 50% per commodity for a maximum return of 50%

  12. Option-based NPPNs

  13. Introduction The value proposition Allows you to customize the payoff profile of an equity investment Not possible with any other investment vehicle The payoff profile of traditional equities is very limiting Most clients understand that they need core equity exposure However, the payoff profile of traditional equities is represented by a 45 degree line 1:1 participation in positive market performance 1:1 participation in negative market performance The problem is that the 45 degree line Is the only payoff profile available for traditional equities Does not necessarily reflect your investment view Option-based NPPNs

  14. Option-based NPPNs Payoff profile of a traditional equity investment 50% 30% Investment Return 0% -30% Initial Price -50% -40% -30% -20% -10% 10% 20% 30% 40% 50% Market Value of Underlying

  15. Advantages You can modify the 45 degree line At very low cost In small amounts ($2 to 3 MM depending on term) No other investment vehicle offers this flexibility Currently, most payoffs are designed to provide attractive returns in flat markets The “Booster” structure The “Double Up” and “Triple-Up” structures Can be structured with varying levels of principal protection (“Buffer” structure ) Important not to pay for more principal protection than you need Option-based NPPNs

  16. Option-based NPPNs Maturity payoff profile of Triple-Up structure 18% • Client Rationale • Has core equity exposure • Concerned about mediocre returns • Willing to cap market upside • Does not want principal protection Note Value at Maturity 0% Index Return -18% Note Return Strike Price 5% 10% 15% 20% 25% -25% -20% -15% -10% -5% 1 year term, 18% cap Market Value of Underlying

  17. Option-based NPPNs Maturity payoff profile of Booster structure 50% 30% • Client Rationale • Has core equity exposure • Concerned about mediocre returns • Not willing to cap market upside • Does not want principal protection Note Value at Maturity 0% -30% Index Return Note Return -50% Strike Price 10% 20% 30% 40% 50% -50% -40% -30% -20% -10% Market Value of Underlying 3 year, 30% booster

  18. Option-based NPPNs Maturity payoffof Buffered Triple Up structure 32% 24% 16% 8% • Client Rationale • Has core equity exposure • Concerned about mediocre returns • Willing to cap market upside • Wants some principal protection Note Value at Maturity 0% -8% -16% -24% -32% Index Return Note Return Strike Price 8% 16% 24%32% -32% -24% -16% -8% Market Value of Underlying 3 year, 24.3% cap, 20% buffer

  19. Option-based NPPNs Maturity payoff of Buffered Protection structure 80% 58% 40% • Client Rationale • Has core equity exposure • Wants significant principal protection • Wants market upside potential • Willing to accept cap on upside Note Value at Maturity 0% -40% -80% Index Return Note Return Strike Price 20% 40% 60%80% -80% -60% -40% -20% Market Value of Underlying 5 year, 58% cap, 40% buffer

  20. Long Equity NPPNs

  21. Introduction The value proposition Enables very efficient access to compelling high turnover “long” equity strategies The embedded equity strategies may be created by The client or advisor RBC Research Zyblock: Strategic / tactical (“Conservative Dividend RoC Security”) McAlpine: Quant (“SPARQS” and “Canadian Bank Yield RoC Security”) Typically provides one or more of the following benefits Tax efficiency No CG tax triggered on rebalancing of the underlying portfolio ROC treatment on income distributions Operational efficiency “One ticket solution” (no trading required by client/advisor) No transaction costs (all costs to client reflected in annual fee) Long Equity NPPNs

  22. Long Equity NPPNs Advantages of NPPN tax efficiency The structure of the note defers any tax consequences until maturity or disposition. Assumptions: • 15% Annualized Return • 5-Year Holding Period • 34% Tax Rate Source: Bourbonniere Paul, Polson Bourbonniere Financial Planners, Five Keys to successful investing, Money Digest Oct. 2000.

  23. Description Simplified investable version of McAlpine’s Quads Score Top 40 model 1:1 “up and down” participation in the total return of an RBC 8 factor quant model Strategy developed by Chad McAlpine, RBC Quantitative Research Universe is 100 largest dividend paying TSX Composite stocks (ex. RY and trusts) 100 stock universe ranked monthly based on equal weighting of 8 quantitative factors 25 stocks with highest score chosen from 100 stock universe 25 stock portfolio rebalances quarterly back to equal weights Dividends reinvested quarterly (indicated yield 2.65%) Very strong back testing vs. TSX composite over 20 years Advantages Tax efficiency (no tax triggered on portfolio rebalancing) Operational efficiency (“one ticket solution” with no transaction costs) Daily secondary market Can be customized (maturity, selling commission, etc.) Long Equity NPPNs RBC “SPARQS” Security

  24. Long Equity NPPNs RBC “SPARQS” Security The Universe S&P/TSX Composite Member Dividend yielding large-cap Canadian equities Must Pay a Dividend The SPARQS Portfolio Excluding Trusts Excluding RY • 25 stocks • The portfolio is traded monthly – annual turn over is 120% • Replacement buys are the best-ranked stocks not already held by the portfolio • Only the largest 100 qualifiers by market cap are eligible to be bought • Stocks are sold if they drop below the 50th position in terms of their rank • At the end of each quarter the portfolio is rebalanced to equal weights The Model Rank stocks based on an equally weighted combination of 8 factor models that fall into 4 distinct investment themes x 1/8 ATTRACTIVE VALUATIONS Low Price to Earnings x 1/8 Low Price to Book Value x 1/8 SUSTAINABLE GROWTH High Quarterly Earnings Growth x 1/8 High Return On Equity x 1/8 POSITIVE SENTIMENT High Earnings Surprise x 1/8 High Estimate Revisions x 1/8 MARKET RECOGNITION High 3-Month Price Change x 1/8 High 6-Month Price Change = Total Score

  25. Long Equity NPPNs RBC “SPARQS” Security Hypothetical 25 stock portfolio – unitized total return vs. QuaDS Canada Large Cap Top 40 Over the past 10 years, the portfolio has performed in line with our Canada Large Cap Top 40.

  26. Description 1:1 “up and down” participation in “Dogs of Canadian Banks” strategy Strategy developed by Chad McAlpine, RBC Quantitative Research Portfolio consists of the “Big 6” Canadian bank stocks Portfolio rebalanced quarterly 2 “highest yielders” weighted 50.0% (25% each) 2 next highest yielders weighted 33.3% (16.7% each) 2 lowest yielders weighted 16.7% (8.35% each) Dividends paid quarterly as ROC (indicated yield 4.38%) Very strong back testing vs. S&P / TSX Banks Index and TSX Composite Advantages Tax efficiency (no tax on triggered rebalancing and ROC treatment on distributions) Operational efficiency (“one ticket solution” with no transaction costs) Daily secondary market Can be customized (maturity, selling commissions, etc.) Long Equity NPPNs RBC Canadian Bank Yield RoC Security

  27. Long Equity NPPNs RBC Canadian Bank Yield RoC Security Back-tested performance 16.4% 12.0% 8.1%

  28. Description 1:1 “up and down” participation in a large cap, conservative, dividend strategy Strategy developed by Myles Zyblock, RBC-CM Chief Strategist Portfolio is top yielding 20 large cap Canadian dividend paying stocks on the TSX60 Pay-out ratios cannot exceed 90%. 20 stock portfolio broken into 5 groups of 4 stocks, weighted according to div yield: Top yielders @ 36%, 2nd highest yielders 28%, 3rd highest yielders at 20%, 4th highest yielders at 12% and the lowest yielders at 4% Portfolio is rebalanced quarterly – dividends paid quarterly as ROC Very low correlation to the TSX Composite and the S&P TSX60 Advantages Tax efficiency (no tax on triggered on rebalancing and ROC treatment on distributions) Operational efficiency (“one ticket solution” with no transaction costs) Daily secondary market Can be customized (maturity, distribution type and frequency, etc.) Long Equity NPPNs RBC Conservative Dividend RoC Security

  29. Long Equity NPPNs RBC Conservative Dividend Yield RoC Security Back-tested performance

  30. Long Equity NPPNs RBC Conservative Dividend Yield RoC Security Back-tested yields

  31. Description 1:1 participation in a defensive high turnover “long equity” strategy Compelling alternative to traditional equity investments and hedge funds Simple rules-based strategy developed with Chad McAlpine, RBC Quantitative Research Incorporates defined sell-discipline based on 200 DMA of TSX Comp Note investment allocated on a monthly basis between Equities (i.e. RBC 8 factor quant model); and Fixed income (govt. bonds, rate swaps, T-Bills, BAs etc.) If TSX Comp > 105% of the 200 DMA 100% in equities If TSX Comp > 95% and < 100% of the 200 DMA 50% in equities and 50% in fixed income If TSX Comp < 95% of the 200 DMA 100% in fixed income Long Equity NPPNs Tactical Equity Allocation Model (TEAM) Security

  32. Long Equity NPPNs TEAM Security TSX Composite performance (colour-coded for TEAM asset allocation) At the end of each month, an asset allocation decision can be made based on the level of the S&P/TSX relative to its 200 DMA. To lower turnover, we’ve introduced a +/- 5% band around the moving average of the index. Switch to 50% Equity 50% Fixed Income + 5% - 5% 200 DMA Switch to 100% Equity 100% Fixed Income

  33. Long Equity NPPNs TEAM Security 20 year back-tested performance (FI Investment: 5 year swaps) The Tactical Equity Allocation Model sacrifices some of the upside performance during bull markets to achieve a high degree of downside protection during corrections. Since 1992, this strategy has never suffered a loss greater than 15%.

  34. Long Equity NPPNs TEAM Security 20 year back-tested annual total returns (FI investment: 5 year swaps) Over the past 20 years, this investment approach has only lost money in one year.

  35. Long Equity NPPNs TEAM Security 20 year comparative performance metrics (FI Investment: 5 year swaps)

  36. Advantages (investment strategy) TEAM is not “the market” Beta = 0.38 vs. TSX Comp Concentrated investment portfolio of 25 Canadian stocks Rebalanced every month based on an RBC 8 factor quant model (SPARQS) Very attractive performance and risk-return metrics (20 year back-testing) Annualized total return = 16.00% (vs. 8.60% for TSX) Sharpe ratio = 1.12 (vs. TSX = 0.39) Worst 12 months = -10.70% (vs. -38.20% for TSX) Maximum drawdown = -12.10% (vs. -43.30% for TSX Duration underwater = 21 months (vs. 59 months for TSX) Completely transparent Simple rules-based asset allocation strategy Long Equity NPPNs TEAM Security

  37. Advantages (NPPN structure) Tax efficiency Taxation does not affect investment decisions / asset allocation No tax on triggered rebalancing of equity portfolio (115% turnover) No tax on triggered on allocation from equities to fixed income If dividends / interest retained, tax is deferred until sale and is paid at CG tax rate Distributions can also be paid-out as ROC Operational efficiency “One ticket solution” for IAs RBC-CM executes all trades (no additional transaction costs to investor) Daily secondary market Low upfront management fee to RBC-CM (no “2 and 20”) 5 year = 1.82% (36.4 bps per annum) 10 year = 3.00% (30.0 bps per annum) Can be customized (maturity, selling commission, currency, etc.) Long Equity NPPNs TEAM Security

  38. The Fixed Income Investment The preceding slides assumed FI investment was a 5 year “interest rate swap” Very similar to 5 year Govt. of Canada bonds 5 year duration No credit risk for investor The bond “bull market” did help returns of the TEAM strategy However, TEAM significantly outperformed the TSX if FI Investment was BAs ... Long Equity NPPNs TEAM Security

  39. Long Equity NPPNs TEAM Security – 3 Month BAs 20 year back-tested performance (FI Investment: 3 month BAs) The Tactical Equity Allocation Model sacrifices some of the upside performance during bull markets to achieve a high degree of downside protection during corrections. Since 1992, this strategy has never suffered a loss greater than 15%.

  40. Long Equity NPPNs TEAM Security – 3 Month BAs 20 year back-tested annual returns (FI Investment: 3 month BAs) Over the past 20 years, this investment approach has only lost money in 3 years.

  41. Long Equity NPPNs TEAM Security – 3 Month BAs 5-Year Trailing Total Return (Annualized)

  42. Long Equity NPPNs TEAM Security – 3 Month BAs 20 year performance statistics (FI Investment: 3 month BAs)

  43. TEAM Strategy looks compelling for U.S. market too Over past 20 years, TEAM has significantly outperformed S&P 500 It does not matter whether FI Investment was 5 year swaps or 3 month T-Bills Long Equity NPPNs TEAM Security – U.S. Market

  44. Long Equity NPPNs TEAM Security – U.S. Market 20 year back-tested performance (FI Investment: 5 year swaps) The Tactical Equity Allocation Model sacrifices some of the upside performance during bull markets to achieve a high degree of downside protection during corrections. Since 1992, this strategy has never suffered a loss greater than 15%.

  45. Long Equity NPPNs TEAM Security – U.S. Market 20 year back-tested annual returns (FI Investment: 5 year swaps) Over the past 20 years, this investment approach has only lost money in one year. In addition, in all but two years it has generated an annual return of more than 5%.

  46. Long Equity NPPNs TEAM Security – U.S. Market 20 year performance statistics (FI Investment: 5 year swaps)

  47. Long Equity NPPNs TEAM Security – U.S. Market 20 year back-tested performance (FI Investment: 3 month T-Bills) The Tactical Equity Allocation Model sacrifices some of the upside performance during bull markets to achieve a high degree of downside protection during corrections. Since 1992, this strategy has never suffered a loss greater than 15%.

  48. Long Equity NPPNs TEAM Security – U.S. Market 20 year back-tested annual return (FI Investment: 3 month T-Bills) Over the past 20 years, this investment approach has only lost money in one year. In addition, in all but two years it has generated an annual return of more than 5%.

  49. Long Equity NPPNs TEAM Security – U.S. Market 5-Year Trailing Total Return (Annualized)

  50. Long Equity NPPNs TEAM Security – U.S. Market 20 year performance statistics (FI Investment: 3 month T-Bills)

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