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Paulson Credit Opportunities

590 Madison Avenue New York, New York 10022

Investor Relations Phone: (212) 956-2221 Fax: (212) 977-9505 www.paulsonco.com

2007 Year End Report

The Paulson Credit Opportunities (“PCO”) funds had an extraordinary year. We thank all our investors for participating with us and sharing in these phenomenal results. The table below summarizes our net returns for the year.

Paulson Credit Opportunities LP

Paulson Credit Opportunities Ltd

Paulson Credit Opportunities II LP

Paulson Credit Opportunities II Ltd

January

9.6%

9.6%

7.3%

7.2%

February

66.9%

66.9%

35.3%

35.1%

March

-6.3%

-6.3%

-2.7%

-2.7%

April

-3.6%

-3.6%

-3.8%

-3.8%

May

-0.8%

-0.8%

-3.9%

-3.9%

June

40.0%

39.9%

23.1%

23.0%

July

75.7%

75.7%

55.8%

55.8%

August

26.5%

26.5%

32.1%

32.1%

September

4.9%

4.9%

3.7%

3.7%

October

21.6%

21.6%

25.5%

25.4%

November

5.7%

5.7%

4.6%

4.6%

December

0.4%

0.4%

0.7%

0.7%

2007

591.3%

589.7%

352.9%

351.7%

2007 Overview

The principal focus of our funds was to capture the gross mispricing of risk in the credit markets by shorting the lower tranches of subprime securities. While spreads at the end of 2006 for 2006 vintage “BBB” subprime securities were in the 100 bps range, by the end of 2007 the securities had fallen from par to 20 and spreads had widened to over 3000 bps.

The impetus for our trade began in 2005 from what we believed was an overvalued housing market due to low U.S. interest rates and high levels of global liquidity. House prices rose between 2000 and 2005 at five times the rate of the previous 25 years leading to what we believed was a housing bubble. We also believed that the subsequent tightening of the Fed Funds Rate from 1% to 5.25%, with a lag effect, would cause house prices to fall.

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. Performance results described herein are net of fees and expenses and assume reinvestment of dividends and capital gains for the periods indicated. Past performance is not necessarily indicative of future performance. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed.

- 2 -

Estimation of Housing Bubble: Comparison of Recent Appreciation vs. Historical Trends

Real Home Price Index (1975=100) Real Home Price Index (1975 = 100) 200 180 Housing
Real Home Price Index (1975=100)
Real Home Price Index (1975 = 100)
200
180
Housing Bubble
160
140
Trend line 1975-2000
120
100
1975
1980
1985
1990
1995
2000
2005
2Q
2007
1.4%
7.6%
CAGR

Source: OFHEO, Bureau of Economic Analysis

The rapid rise in house prices led to a decrease in mortgage credit losses leading to an explosion in subprime mortgage issuance. By 2006, subprime mortgage securitization reached $500 billion, bringing the total amount outstanding to $1.3 trillion, equal to approximately 14% of the total mortgage market, compared to less than 1% in 1994.

$bn

700

600

500

400

300

200

100

0

Subprime Mortgage Origination

Subprime Mortgage Origination

13.6% SOM 0.9% SOM '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04
13.6%
SOM
0.9%
SOM
'94
'95
'96
'97
'98
'99
'00
'01
'02
'03
'04
'05
06

This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 3 -

Concurrent with the explosion in volume was a substantial deterioration in credit quality, as the percentage of loans with 100% financing, no income verification, or both, increased dramatically.

Combined Loan to Value Combined Loan to Value Combined Loan to Value Combined Loan to
Combined Loan to Value
Combined Loan to Value
Combined Loan to Value
Combined Loan to Value
Combined Loan to Value
Piggyback %
Piggyback %
Piggyback %
100% Financing
100% Financing
33%
33%
33%
90
90 90
89.1
89.1
89.1
35%
35%
35%
87.4
87.4
87.4
30%
30%
30%
88
88 88
24%
24%
24%
25%
25%
25%
86 86
86
85.0
85.0
85.0
20%
20%
20%
16%
16%
16%
84
84 84
82.3
82.3
82.3
15%
15%
15%
82
82 82
8%
8%
8%
10%
10%
10%
80.5
80.5
80.5
79.8
79.8
79.8
80
80 80
3%
3%
3%
3%
3%
3%
5%
5%
5%
0%
0%
0%
78 78
78
2001
2001
2001
2002
2002
2002
2003
2003
2003
2004
2004
2004
2005
2005
2005
2006
2006
2006
2001
2001
2001
2002
2002
2002
2003
2003
2003
2004
2004
2004
2005
2005
2005
2006
2006
2006
Limited Documentation %
Limited Documentation %
Limited Documentation %
Piggyback & Limited Doc %
Piggyback & Limited Doc %
Piggyback & Limited Doc %
Limited Documentation
Limited Documentation
100% Financing & Limited Doc %
100% Financing & Limited Doc %
44%
44%
44%
45%
45%
45%
16%
16%
16%
15%
15%
15%
41%
41%
41%
12%
12%
12%
40%
40%
40%
38%
38%
38%
12%
12%
12%
35%
35%
35%
35%
35%
35%
31%
31%
31%
7%
7%
7%
8%
8%
8%
30%
30%
30%
27%
27%
27%
3%
3%
3%
4%
4%
4%
25%
25%
25%
1%
1%
1%
1%
1%
1%
20%
20%
20%
0%
0%
0%
2001
2001
2001
2002
2002
2002
2003
2003
2003
2004
2004
2004
2005
2005
2005
2006
2006
2006
2001
2001
2001
2002
2002
2002
2003
2003
2003
2004
2004
2004
2005
2005
2005
2006
2006
2006

Source: Loan Performance

The growth in subprime originations was also fueled by the growth in the mortgage backed securities market. Mortgages originated by third parties (New Century, Ameriquest, Accredited, Saxon, etc.) were then sold to investment banks who repackaged these mortgages into Residential Mortgage Backed Securities (“RMBS”) and sold them to investors around the world. Each RMBS structure is sliced into various tranches (18 on average) with each higher rated tranche being structurally senior to the junior tranches in the event of loss. Demand for these securities was so high, and perception of risk so low, that the “BBB” tranche in the example

This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 4 -

below, which had only 5.6% subordination and was only 1.4% thick, yielded only slightly more than 1% above LIBOR. In other words, for an extra 1% yield, the investor risked losing all of his capital if the cumulative loss exceeded 7%.

Subprime Residential Mortgage-Backed Securitization Example

ACE Securities Corp - ACE 2006-HE1

Class

Ratings

Class Amount Outstanding

Subordination

Spread to

One- Month

LIBOR

A1A

Aaa (AAA)

$ 757,819,000

0.14

A1B1

Aaa (AAA)

417,082,000

0.15

A1B2

Aaa (AAA)

104,270,000

0.15

A2A

Aaa (AAA)

356,980,000

0.04

A2B

Aaa (AAA)

127,685,000

0.09

A2C

Aaa (AAA)

88,606,000

0.15

A2D

Aaa (AAA)

78,490,000

23.9%

0.25

M1

Aa1 (AA+)

101,428,000

19.9%

0.27

M2

Aa2 (AA)

92,553,000

16.2%

0.29

M3

Aa3 (AA-)

57,053,000

14.0%

0.30

M4

A1 (A+)

48,178,000

12.1%

0.45

M5

A2 (A)

45,643,000

10.3%

0.48

M6

A3 (A-)

41,839,000

8.6%

0.58

M7

Baa1 (BBB+)

40,571,000

7.0%

0.95

M8

Baa2 (BBB)

36,768,000

5.6%

1.35

M9

Baa3 (BBB-)

26,625,000

4.5%

2.45

M10

Ba1 (BB+)

31,696,000

3.3%

5.50

Over Collateralization

82,415,903

$

2,535,701,903

Through extensive internal research efforts we determined that the cumulative losses in subprime mortgage pools were highly correlated with home price appreciation (“HPA”). In periods of very rapid HPA, losses were de minimis, but as HPA slowed, losses rose. Our analysis of historical data, in concert with research work from several investment banks, estimated that at 0% HPA cumulative losses would be in the 7% range and at a negative 5% HPA losses would rise to the high teens.

This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

Loss

Loss

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

- 5 -

Cumulative Loss for Various HPA Scenarios Cumulative Loss for Various HPA Scenarios 17.5% 7.1% June
Cumulative Loss for Various HPA Scenarios
Cumulative Loss for Various HPA Scenarios
17.5%
7.1%
June '06: 83 bps
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%

Home Price Appreciation ("HPA")

By June 2006, when we started PCO, HPA had already slowed to a 1% rate having declined rapidly from over 15% only one year earlier. Given the degree to which we estimated housing was overvalued, we forecast the rapid deceleration in home prices would likely continue and that 0% to negative 5% HPA was highly probable. In such a scenario, the losses in 2006 RMBS securitizations would likely exceed 7% and wipe out the “BBB” tranches. Yet the demand for “BBB” remained strong, securitization volume continued to grow and spreads continued to tighten.

House Prices $K Seasonally Adjusted

Existing Home Sales Median Price

Existing Home Sales Median Price

Last Points: Jul 2006 240 18% 16% 220 14% $222 200 12% 10% 180 8%
Last Points: Jul 2006
240
18%
16%
220
14%
$222
200
12%
10%
180
8%
160
6%
4%
140
2%
1 %
120
0%
01/01
07/01
01/02
07/02
01/03
07/03
01/04
07/04
01/05
07/05
01/06
07/06
Level (thous., left scale)
year/year % change (right scale)
Source: National Association of Realtors &
A. Gary Shilling and Company

Source: Merrill Lynch, Paulson estimates

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 6 -

We were astounded at the mispricing of these securities and after reaching our target short positions in the Merger and Event Funds we set up Paulson Credit Opportunities (“PCO”) to take a more concentrated short position in these securities. The PCO funds targeted a 12:1 notional short position to equity. Although the notional short position was large, PCO would only have a negative carry of 7% net per year (12% gross at 100 bps spread less 5% earned on cash balances). Below is the table estimating returns as part of our investor presentation in June 2006.

Notional Notional Short Short

Position Position Multiple Multiple

Annual Annual

Cost Cost

Potential Potential Gross Gross Return Return

Assuming Assuming Loss Loss of: of:

 

to to Equity Equity

(bps) (bps)

30% 30%

50% 50%

80% 80%

Advantage Advantage Fund Fund

2.3X 2.3X

216 216

62% 62%

104% 104%

166% 166%

Merger Merger Fund Fund

1.7X 1.7X

150 150

38% 38%

64% 64%

102% 102%

 

(a)

Credit Credit Fund Fund

12.0X 12.0X

709 709

341% 341%

568% 568%

909% 909%

(a) Net. After 500bps earned on cash collateral.

As 2006 progressed, the underlying performance of subprime loans continued to deteriorate. Remarkably, the demand for the “BBB” securities remained strong and spreads remained tight. We viewed this as a window of opportunity to continue to raise money to short the securities for PCO and, starting January 1, 2007, for PCO II. While we shorted the ABX Index, the bulk of our short position was concentrated in individual RMBS securities that we believed were of inferior quality to the Index and which traded at tighter spreads.

The subprime securities charade finally came to an end in 2007 as home prices continued to decline, delinquencies continued to rise, and the prices of the “BBB” tranches plummeted.

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 7 -

Existing Home Sales Median Price

Existing Home Sales Median Price

House Prices $K Seasonally Adjusted Last Points: Oct 2007 240 18% 16% 220 14% 12%
House Prices $K
Seasonally Adjusted
Last Points: Oct 2007
240
18%
16%
220
14%
12%
200
10%
$210
8%
180
6%
4%
160
2%
0%
140
-2%
-4%
-5.1 %
120
-6%
01/01
07/01
01/02
07/02
01/03
07/03
01/04
07/04
01/05
07/05
01/06
07/06
01/07
07/07
Level (thous., left scale)
year/year % change (right scale)
Source: National Association of Realtors &
A. Gary Shilling and Company

60 Day+ Delinquency and Foreclosure

 

2006

2007

% Change YoY

January

5.6%

9.4%

68.6%

February

5.8%

9.9%

71.9%

March

5.8%

10.4%

79.0%

April

5.6%

10.7%

91.3%

May

5.9%

11.3%

92.0%

June

5.8%

12.2%

109.7%

July

6.0%

13.4%

121.7%

August

6.5%

14.8%

127.4%

September

6.8%

16.3%

139.3%

October

7.4%

18.1%

145.3%

November

8.0%

19.9%

150.5%

December

8.6%

22.0%

155.2%

Source: Loan Performance

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 8 -

“BBB” Prices

ABX HE BBB 06-2 ABX HE BBB 07-1
ABX HE BBB 06-2
ABX HE BBB 07-1

Source: Markit

CDOs

An important related market to the subprime securities market was the market for Collaterized Debt Obligations (“CDO”). CDOs used as collateral various “synthetic” tranches of subprime securities, which were then repackaged into securities and sold to investors. An estimated $320 billion of CDOs backed by subprime securities were issued in 2006 and 2007 as follows.

2006/2007

Volume ($ in billions)

Collateral

Mezzanine

$129

“BBB” Securities AA/A Subprime RMBS and Mezzanine CDO’s AA/A Mezzanine CDO’s

High Grade

167

CDO Squared

24

Total

$320

Source: Merrill Lynch

The hypocrisy of the CDOs was that Mezzanine CDOs, consisting exclusively of “BBB” collateral, somehow had 70% of their capital structure rated AAA. It is the AAA CDO securities that are causing so much turmoil in the markets as their holders (Merrill Lynch, Morgan Stanley, Citibank, UBS, Wachovia) or their guarantors (Ambac, MBIA, ACA) are forced to write them down.

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 9 -

Mortgage Collateral

Mortgage Collateral

RMBS Securitization

RMBS Securitization

RMBS Collateral

RMBS Collateral

Portfolio of

Portfolio of

2006 2006

Sub-Prime

Sub-Prime

Residential

Residential

Mortgages

Mortgages

Residential Residential Mortgages Mortgages AAA rated AAA rated tranches tranches (80% of

AAA rated

AAA rated

tranches

tranches

(80% of

(80% of

capital

capital

structure)

structure)

AA tranches (9%)

AA tranches (9%)

A A

tranches (3%)

tranches (3%)

BBB+/BBB/BBB- (4%)

BBB+/BBB/BBB- (4%)

BB tranches (2%)

BB tranches (2%)

Residual (2%)

Residual (2%)

Portfolio of

Portfolio of

BBB and BBB-

BBB and BBB-

tranches

tranches

of RMBS

of RMBS

securitizations

securitizations

CDO Securitization

CDO Securitization

securitizations CDO Securitization CDO Securitization AAA rated AAA rated tranches tranches (75% of

AAA rated

AAA rated

tranches

tranches

(75% of

(75% of

capital

capital

structure)

structure)

AA tranche (12%)

AA tranche (12%)

A A

tranche (4%)

tranche (4%)

BBB tranche (4%)

BBB tranche (4%)

Equity (5%)

Equity (5%)

The value of the CDO securities is simply nothing more than the value of the underlying collateral. If the “BBB” collateral is worthless then the CDO is worthless. This obvious truth is becoming painfully apparent as CDO securities are being downgraded and liquidated.

CDO Pricing Implied Pricing Based on Value of Underlying Collateral (a)

Value of

Super

"BBB"

Senior

Junior

Collateral

AAA

AAA

AA

A

BBB

Equity

100

100

100

100

100

100

100

90

100

100

100

100

28

0

80

100

100

81

0

0

0

70

100

95

0

0

0

0

60

100

30

0

0

0

0

50

90

0

0

0

0

0

40

72

0

0

0

0

0

30

54

0

0

0

0

0

20

36

0

0

0

0

0

10

18

0

0

0

0

0

0000000

This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

2008 Outlook

- 10 -

In general, we expect the U.S. credit correction to continue to worsen in 2008. We believe the decline in nationwide home prices will accelerate in 2008 ultimately falling 15% to 25% from the peak compared to a decline of only 5% as of November 2007.

Real Home Price Index (1975=100) Real Home Price Index (1975=100) 200 180 Housing Bubble 160
Real Home Price Index (1975=100)
Real Home Price Index (1975=100)
200
180
Housing Bubble
160
140
Trend line 1975-2000
120
100
1975
1980
1985
1990
1995
2000
2005
3Q
2007
1.4%
7.6%
CAGR

Source: OFHEO, Paulson estimates

Recent trends in the housing market support this outlook as existing sales continue to fall at a dramatic rate, inventories of unsold homes continue to skyrocket and the availability of mortgage finance continues to contract.

Existing Home Sales

Existing Home Sales

(SAAR, millions) (SAAR, millions) 7.5 7.0 6.5 6.0 5.5 5.0 4.5 01/99 01/00 01/01 01/02
(SAAR, millions)
(SAAR, millions)
7.5
7.0
6.5
6.0
5.5
5.0
4.5
01/99
01/00
01/01
01/02
01/03
01/04
01/05
01/06
01/07

Source: National Association of Realtors

This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 11 -

Existing Homes Inventory Existing Homes Inventory (Months Supply) (Months Supply) 11 10 9 8 7
Existing Homes Inventory
Existing Homes Inventory
(Months Supply)
(Months Supply)
11
10
9
8
7
6
5
4
3
01/99
01/00
01/01
01/02
01/03
01/04
01/05
01/06
01/07

Source: National Association of Realtors

Mortgage Securitization Volume

December ‘07 vs. December ‘06

Subprime Subprime 60 60 Alt-A Alt-A Jumbo Jumbo $55.7 bn $55.7 bn 50 50 40
Subprime
Subprime
60 60
Alt-A
Alt-A
Jumbo
Jumbo
$55.7 bn
$55.7 bn
50 50
40 40
$37.6 bn
$37.6 bn
30 30
100% decline
100% decline
20 20
$16.5 bn
$16.5 bn
98% decline
98% decline
77% decline
77% decline
10 10
$3.8 bn
$3.8 bn
$0.9 bn
$0.9 bn
$0 bn
$0 bn
0 0
Dec '06
Dec '06
Dec '07
Dec '07
Dec '06
Dec '06
Dec '07
Dec '07
Dec '06
Dec '06
Dec '07
Dec '07
This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any
of this material is strictly prohibited.

- 12 -

The decline in home prices will lead to a substantial reduction in U.S. Household wealth, which together with reduced credit availability, will lead to a decline in consumer spending and to a likely recession. Credit problems will expand beyond subprime mortgages to include: Alt-A, jumbo, and prime mortgages; consumer credit, such as home equity loans, auto loans, student loans and credit card loans; commercial mortgages; bank loans; and also extend to the corporate bond market. We believe the increase in credit costs will continue to stress financial institutions causing spreads to widen and causing certain institutions to fail.

Banks & Brokerages: Stressed Balance Sheets

 

A

B

C

D

E

F

Tangible Assets / Tangible Equity

25.9x

30.0x

20.2x

31.4x

42.5x

38.5x

Price / Tangible BVPS

3.3

2.3

2.1

0.9

2.2

0.9

Level 2 Assets / TCE

10.7x

12.2x

13.1x

14.9x

10.9x

19.4x

Level 3 Assets / TCE

0.5

1.7

0.8

1.6

2.3

2.9

Combined Level 2 and Level 3

11.2x

13.9x

13.9x

16.5x

13.2x

22.3x

Asset Quality – as % of TCE

 

Subprime CDO Exposure, Net

20.8%

55.8%

0.0%

N.A.

N.A.

N.A.

Subprime Loans on Balance Sheet

4.8%

58.4%

16.9%

N.A.

N.A.

N.A.

Home Equity Lines of Credit

191.2%

46.7%

131.6%

N.A.

N.A.

N.A.

Leveraged Loans

48.4%

74.0%

57.4%

N.A.

N.A.

N.A.

Maximum Exposure to Loss from Unconsolidated VIEs

122.2%

182.9%

136.0%

N.A.

N.A.

N.A.

Credit Card Lines

1536%

1337%

991%

N.A.

N.A.

N.A.

Credit Derivatives Notional (Gross) / TCE

51.0x

45.9x

110.0x

N.A.

N.A.

N.A.

CDS Notional Exposure

Beginning six months ago, to benefit from the anticipated credit contraction, we purchased protection on a select group of financial institutions. We have long felt that the excesses in the credit markets were not confined to subprime mortgage securities and that other parts of the credit market would subsequently correct. In total, the notional value of our corporate CDS position exceeds the peak amount of our subprime protection by a factor of 1.5x. While we don’t expect from the corporate credit short the same level of gain that we realized from the subprime short, we do believe a deeper credit correction can produce large gains for the funds. Conversely, if the correction in the credit markets are less than anticipated the cost of the protection is relatively de minimis. Our CDS exposure relative to our remaining subprime exposure is shown below.

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 13 -

Corporate and RMBS CDS Exposure

1.80 Corporate CDS 1.60 1.40 1.20 1.00 CDS on RMBS 0.80 0.60 0.40 0.20 -
1.80
Corporate
CDS
1.60
1.40
1.20
1.00
CDS on
RMBS
0.80
0.60
0.40
0.20
-
N o tio n al
/
A sse ts

Long Opportunities

Credit Funds

We constantly monitor the market for long opportunities. However, we believe initiating long positions in the current market is premature. Anyone who has jumped in to buy either subprime, leveraged loans, distressed debt, or bank equity securities has lost money so far as the securities have traded lower.

However, we believe in the future there will be extremely attractive long opportunities in the debt markets which we will be uniquely positioned to capture. In the subprime mortgage market, for instance, there are over 1,000 different RMBS securitizations with each one divided into approximately 18 tranches, creating over 18,000 individual securities. The chart below highlights the enormous size of the opportunities relative to the limited capital we have under management.

Long Distressed Mortgage Opportunities

2.5 2.5

2 2

1.5 1.5

1 1

0.5 0.5

0 0

$2.4 Trillion $2.4 Trillion - - Alt-A Alt-A - - Subprime Subprime - - PCO
$2.4 Trillion
$2.4 Trillion
-
-
Alt-A
Alt-A
-
-
Subprime
Subprime
-
-
PCO
PCO

1000 subprime RMBS deals

1000 subprime RMBS deals

18 tranches per deal

18 tranches per deal

18,000 permutations of securities

18,000 permutations of securities

Universe 267x PCO fund AUM

Universe 267x PCO fund AUM

The above represents a partial list of deals and is presented for illustrative purposes only. There is no guarantee that in the future these securities will be held in the Paulson funds. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 14 -

We estimate that the vast majority of the holders of these securities have limited ability to analyze the securities at the loan level and merely bought the securities based on their ratings. As the fundamentals deteriorate, we believe the $1.2 trillion subprime market and the $1.2 trillion Alt-A market will become busted markets. We anticipate there will be billions of further downgrades of investment grade bonds to non-investment grade status forcing the sales by holders who are restricted from holding non-investment grade securities. Estimating where the loss will stop and which of the 18,000 tranches offers the best risk adjusted return is an extremely complex task. Again, given our research expertise in analyzing individual securities, we believe we will be uniquely positioned to benefit from future long opportunities in this market.

Conclusion

As investors in PCO we all have much to be grateful. We succeeded in not only avoiding one of the greatest credit collapses in financial history but, by taking the other side, to have earned some of the highest returns ever achieved by a hedge fund. We thank our clients for having both the investment foresight and confidence in us as managers to allow our PCO funds to succeed.

This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

- 15 -

This material may not be distributed to other than the intended recipient. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.

This document does not constitute an offer to sell or a solicitation of an offer to buy any securities, and may not be relied upon in connection with any offer or sale of securities. This document should be read in conjunction with, and is qualified in its entirety by, information appearing in the Confidential Private Offering Memorandum (and a Limited Partnership Agreement for domestic partnerships), which should be carefully reviewed prior to investing. Past performance is not necessarily indicative of future performance, and although the Advantage Funds may invest in some of the same securities as the Merger Funds, the broader strategy may result in performance that is different from that of the Merger Funds.

An investment in a hedge fund is speculative and involves a high degree of risk, which each investor must carefully consider. An investor in hedge funds could lose all or a substantial amount of his or her investment. Returns generated from an investment in a hedge fund may not adequately compensate investors for the business and financial risks assumed. While hedge funds are subject to market risks common to other types of investments, including market volatility, hedge funds employ certain trading techniques, such as the use of leveraging and other speculative investment practices that may increase the risk of investment loss. Products may involve above-average risk. Risks associated with hedge fund investments include, but are not limited to, the fact that hedge funds can be highly illiquid; they are not required to provide periodic pricing or valuation information to investors; they may involve complex tax structures and delays in distributing important tax information; they are not subject to the same regulatory requirements as mutual funds; they often charge higher fees and the high fees may offset the funds’ trading profits; they may have a limited operating history; they can have performance that is volatile; they may have a fund manager who has total trading authority over the fund and the use of a single adviser applying generally similar trading programs could mean a lack of diversification, and consequentially, higher risk; they may not have a secondary market for an investor’s interest in the fund and none may be expected to develop; they may have restrictions on transferring interests in the fund; and may effect a substantial portion of their trades on foreign exchanges. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed.

The above represents the performance of all the Funds and is presented for illustrative purposes only. Performance results described herein are net of fees and expenses and assume reinvestment of dividends and capital

The above represents the performance of all the Funds and is presented for illustrative purposes only. Performance results described herein are net of fees and expenses and assume reinvestment of dividends and capital

gains for the periods indicated. The investment strategy for the Merger Funds changed materially after 1998, since which time the Merger Funds avoided investing in event-type situations. While the Advantage Funds

gains for the periods indicated. The investment strategy for the Merger Funds changed materially after 1998, since which time the Merger Funds avoided investing in event-type situations. While the Advantage Funds

Merger and Advantage Funds. Past performance is not necessarily indicative of returns the funds may achieve in the future.

Merger and Advantage Funds. Past performance is not necessarily indicative of returns the funds may achieve in the future.

may invest in some of the same securities as the Merger Funds, the broader strategy of the Advantage Funds may result in performance that differs from that of the Merger Funds. Furthermore, while the Credit

may invest in some of the same securities as the Merger Funds, the broader strategy of the Advantage Funds may result in performance that differs from that of the Merger Funds. Furthermore, while the Credit

Opportunities Funds may invest in some of the same securities as the Merger and Advantage Funds, the more focused strategy of the Credit Opportunities Funds may result in performance that differs from that of the

Opportunities Funds may invest in some of the same securities as the Merger and Advantage Funds, the more focused strategy of the Credit Opportunities Funds may result in performance that differs from that of the

4. 4.

5. 5.

2 2

PAPLP and PA P - Paulson A dvantage Plus LP and Paulson A dvantage Plus Ltd. started January 2005 (1.5X weighted version of PA L)6.

PAPLP and PA P - Paulson A dvantage Plus LP and Paulson A dvantage Plus Ltd. started January 2005 (1.5X weighted version of PA L)6.

8. 8.

7. 7.

Estimates are italicised

Estimates are italicised

3. 3.

1. 1.

. P IL - P aulson Int e r national L td. star t e d M ay 19 9 6

. P IL - P aulson Int e r national L td. star t e d M ay 19 9 6

PEL - Paulson Enhanced Limited (PEL) started May 2001.

PEL - Paulson Enhanced Limited (PEL) started May 2001.

PALP and PAL - Paulson A dvantage LP and Paulson A dvantage Ltd. started A pril 2004

PCO LP and PCO L - Paulson Credit LP and Paulson Credit Ltd. started July 2006

PCO LP and PCO L - Paulson Credit LP and Paulson Credit Ltd. started July 2006

PALP and PAL - Paulson A dvantage LP and Paulson A dvantage Ltd. started A pril 2004

PPE - Paulson Partners Enhanced started May 2003 (2X weighted version of PPLP)

PPE - Paulson Partners Enhanced started May 2003 (2X weighted version of PPLP)

PC O

PC O

PPLP -

PPLP -

II L P

II L P

Paulson Partners LP started July 1994

Paulson Partners LP started July 1994

and PC O

and PC O

II L

II L

- Paulson C r e dit II L P and Paulson C r e dit II L td. star te d Januar y 2007

- Paulson C r e dit II L P and Paulson C r e dit II L td. star te d Januar y 2007

Ordinary common shares presented ( 2X we ig hte d ve r sion of P IL )

Ordinary common shares presented ( 2X we ig hte d ve r sion of P IL )

Life of Fund

Life of Fund

Five Ye ar

Five Ye ar

Three Year

Three Year

One Ye ar

One Ye ar

 

17.78%

17.78%

20.40%

20.40%

22.59%

22.59%

51.74%

51.74%

15.13%

15.13%

20.02%

20.02%

22.57%

22.57%

51.70%

51.70%

39.76%

39.76%

--

--

44.52%

44.52%

118.91%

118.91%

29.24%

29.24%

39.94%

39.94%

43.83%

43.83%

116.47%

116.47%

Compound A nnual G rowth Rates (as of January 1, 2008)

Compound A nnual G rowth Rates (as of January 1, 2008)

28.65%

28.65%

--

--

31.08%

31.08%

99.79%

99.79%

       

28.51%

28.51%

--

--

31.30%

31.30%

100.14%

100.14%

       

45.42%

45.42%

--

--

--

--

163.82%

163.82%

       

44.80%

44.80%

--

--

--

--

158.56%

158.56%

 

--

--

--

--

--

--

591.33%

591.33%

--

--

--

--

--

--

589.67%

589.67%

--

--

--

--

--

--

352.92%

352.92%

--

--

--

--

--

--

351.73%

351.73%

- 16 -

YTD

YTD

Dec

Dec

Nov

Nov

Oct

Oct

Sep

Sep

Aug

Aug

Jul

Jul

Jun

Jun

May

May

Apr

Apr

Mar

Mar

Feb

Feb

Jan

Jan

2007

2007

2006

2006

2005

2005

2004

2004

2003

2003

2002

2002

2001

2001

2000

2000

1999

1999

1998

1998

1997

1997

1996

1996

1995

1995

1994

1994

YEA R

YEA R

 

51.74%

51.74%

0.34%

0.34%

-0.11%

-0.11%

4.20%

4.20%

0.97%

0.97%

0.47%

0.47%

11.79%

11.79%

5.99%

5.99%

1.64%

1.64%

0.12%

0.12%

-0.13%

-0.13%

13.29%

13.29%

4.99%

4.99%

 

16.81%

16.81%

3.94%

3.94%

11.92%

11.92%

22.69%

22.69%

4.48%

4.48%

5.04%

5.04%

22.42%

22.42%

23.81%

23.81%

-4.91%

-4.91%

12.71%

12.71%

38.13%

38.13%

18.57%

18.57%

23.46%

23.46%

PPL P 1

PPL P 1

 

51.70%

51.70%

0.63%

0.63%

-0.14%

-0.14%

4.23%

4.23%

0.99%

0.99%

0.45%

0.45%

11.88%

11.88%

6.06%

6.06%

1.64%

1.64%

0.16%

0.16%

-0.03%

-0.03%

12.95%

12.95%

4.67%

4.67%

 

16.45%

16.45%

4.23%

4.23%

12.08%

12.08%

20.70%

20.70%

5.28%

5.28%

5.40%

5.40%

24.72%

24.72%

23.97%

23.97%

-4.42%

-4.42%

14.90%

14.90%

10.31%

10.31%

--

--

--

--

P IL 2

P IL 2

Merger Funds

Merger Funds

                                                       

118.91%

118.91%

0.96%

0.96%

-0.35%

-0.35%

8.92%

8.92%

1.72%

1.72%

1.08%

1.08%

24.32%

24.32%

11.72%

11.72%

2.96%

2.96%

-0.09%

-0.09%

0.23%

0.23%

24.54%

24.54%

8.94%

8.94%

 

31.33%

31.33%

5.00%

5.00%

22.62%

22.62%

29.60%

29.60%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PPE 3

PPE 3

116.47%

116.47%

1.16%

1.16%

-0.58%

-0.58%

8.73%

8.73%

1.69%

1.69%

1.09%

1.09%

23.62%

23.62%

11.49%

11.49%

3.03%

3.03%

-0.09%

-0.09%

-0.02%

-0.02%

24.69%

24.69%

8.88%

8.88%

 

29.99%

29.99%

5.75%

5.75%

24.21%

24.21%

45.20%

45.20%

11.39%

11.39%

-7.53%

-7.53%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PEL 4

PEL 4

 

99.79%

99.79%

1.62%

1.62%

4.03%

4.03%

9.44%

9.44%

0.55%

0.55%

4.75%

4.75%

22.89%

22.89%

11.43%

11.43%

0.38%

0.38%

-0.40%

-0.40%

-0.79%

-0.79%

15.03%

15.03%

4.94%

4.94%

12.57%

12.57%

0.15%

0.15%

14.21%

14.21%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PALP 5

PALP 5

 

100.14%

100.14%

1.70%

1.70%

4.65%

4.65%

11.75%

11.75%

-0.07%

-0.07%

5.14%

5.14%

23.86%

23.86%

10.19%

10.19%

0.66%

0.66%

-0.10%

-0.10%

-0.56%

-0.56%

13.45%

13.45%

3.45%

3.45%

12.80%

12.80%

0.27%

0.27%

13.14%

13.14%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PAL 5

PAL 5

Event Funds

Event Funds

                                                     

163.82%

163.82%

2.04%

2.04%

2.59%

2.59%

12.68%

12.68%

1.59%

1.59%

4.66%

4.66%

33.24%

33.24%

19.30%

19.30%

0.91%

0.91%

-1.48%

-1.48%

-0.71%

-0.71%

23.87%

23.87%

8.24%

8.24%

18.40%

18.40%

-1.55%

-1.55%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PAPLP 6

PAPLP 6

158.56%

158.56%

2.45%

2.45%

3.41%

3.41%

13.08%

13.08%

1.64%

1.64%

5.76%

5.76%

32.79%

32.79%

18.47%

18.47%

0.81%

0.81%

-1.43%

-1.43%

-1.10%

-1.10%

23.22%

23.22%

5.40%

5.40%

19.08%

19.08%

-1.39%

-1.39%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PAP 6

PAP 6

 

591.33%

591.33%

0.40%

0.40%

5.72%

5.72%

21.65%

21.65%

4.94%

4.94%

26.54%

26.54%

75.73%

75.73%

39.98%

39.98%

-0.80%

-0.80%

-3.59%

-3.59%

-6.30%

-6.30%

66.92%

66.92%

9.57%

9.57%

19.92%

19.92%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PCO LP 7

PCO LP 7

 

589.67%

589.67%

0.38%

0.38%

5.70%

5.70%

21.62%

21.62%

4.92%

4.92%

26.51%

26.51%

75.68%

75.68%

39.92%

39.92%

-0.81%

-0.81%

-3.59%

-3.59%

-6.31%

-6.31%

66.88%

66.88%

9.55%

9.55%

19.43%

19.43%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PCO L 7

PCO L 7

Credit Funds

Credit Funds

                                                     

352.92%

352.92%

0.68%

0.68%

4.64%

4.64%

25.46%

25.46%

3.66%

3.66%

32.13%

32.13%

55.80%

55.80%

23.09%

23.09%

-3.92%

-3.92%

-3.81%

-3.81%

-2.73%

-2.73%

35.30%

35.30%

7.26%

7.26%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PC O

PC O

II L P 8

II L P 8

351.73%

351.73%

0.67%

0.67%

4.64%

4.64%

25.45%

25.45%

3.66%

3.66%

32.09%

32.09%

55.77%

55.77%

23.04%

23.04%

-3.92%

-3.92%

-3.78%

-3.78%

-2.74%

-2.74%

35.12%

35.12%

7.21%

7.21%

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

--

PC O

PC O

II L 8

II L 8