State of Connecticut Comprehensive Annual Financial Report Fiscal Year Ended June 30, 1998 - Notes to the Financial Statements

In this note, the State's deposits and investments are classified in categories of "custodial credit risk." This is the risk that the State will not be able to (a) recover deposits if the depository bank fails or (b) recover the value of investments or collateral securities that are in the custody of an outside party if the counterparty to the investment or deposit transaction fails. Classification in category 1 means that the exposure of deposits or investments to potential custodial credit risk is low. The level of potential custodial credit risk is higher for those deposits or investments classified in category 2, and highest for those in category 3.

Cash deposits (amounts in million)
At June 30, l998, the reported amount of the State's deposits was $(133.7) for the Primary Government and $133.0 for the Component Units. The corresponding bank balance for such deposits was $139.3 for the Primary Government and $139.2 for the Component Units. Of the bank balance for the Primary Government $52.6 was insured by the Federal Deposit Insurance Corporation or held by the State's agent in the State's name (Category 1), $8.7 was collateralized (Category 3), and $78.0 was uninsured and uncollateralized (Category 3). Of the bank balance for the Component Units, $12.4 was insured by the Federal Deposit Insurance Corporation or held by the State's agent in the State's name (Category 1), $0.9 was collateralized (Category 3), and $125.9 was uninsured and uncollateralized (Category 3).

Collateralized deposits are deposits which are protected by State statute. Under the statute, any bank holding public deposits must at all times maintain eligible collateral in an amount equal to 10%, 25%, 100%, or 120% of its public deposits. The applicable percentage is determined based on the bank's risk-based capital ratio - a measure of the bank's financial condition. The collateral is kept in the custody of the trust department of either the pledging bank or another bank in the name of the pledging bank.

Investments
The State Treasurer is the chief fiscal officer of State government and is responsible for the prudent management and investment of monies of State funds and agencies as well as monies of pension and other trust funds. Investment policies and guidelines are established by the State Treasurer with the advice of the Investment Advisory Council, whose members include outside investment professionals and pension beneficiaries. Currently, the State Treasurer manages one Short-Term Investment Fund ("STIF") and seven Combined Investment Funds (the "CIFS"), including one international investment fund.

STIF is a money market investment pool in which the State, municipal entities, and political subdivisions of the State are eligible to invest. The State Treasurer is authorized to invest monies of STIF in United States government and agency obligations, certificates of deposit, commercial paper, corporate bonds, saving accounts, bankers' acceptances, repurchase agreements, asset-backed securities, and student loans. STIF's investments are reported at amortized cost (which approximates fair value) and are disclosed in the investments schedules.

For financial reporting purposes, STIF is considered to be a mixed investment pool - a pool having external and internal portions. The external portion of STIF (i.e., the portion that belongs to participants which are not part of the State's financial reporting entity) is reported as an investment trust fund in the combined financial statements. The internal portion of STIF (i.e., the portion that belongs to participants that are part of the State's financial reporting entity) is not reported in the combined financial statements. Instead, each fund type's investment in the internal portion of STIF is reported as "cash equivalents" in the combined balance sheet.

The CIFS are open-end, unitized portfolios in which the State pension and other trust funds are eligible to invest. The units of the CIFS are owned by the State pension and other trust funds. The State Treasurer is also authorized to invest monies of the CIFS in common stock, commercial equity real estate, foreign companies stocks and bonds, commercial and residential mortgages, foreign govern-ments obligations, mortgage-backed securities, and venture capital partnerships. CIFS' investments are reported at fair value and are disclosed in the investments schedules.

For financial reporting purposes, the CIFS are considered to be internal investment pools and are not reported in the combined financial statements. Instead, each fund type's investment in the CIFS is reported as "equity in combined investment funds" in the combined balance sheet.

Complete financial information about STIF and the CIFS can be obtained from financial statements issued by the State Treasurer.

The following investments schedules disclose the reported amount and fair value of the State's investments in total and by investment type as of June 30, 1998. Further, the reported amounts of these investments are classified according to the following categories of custodial credit risk. Category 1 includes investments that are insured or registered or for which the securities are held by the State or its agent in the State's name. Category 2 includes uninsured and unregistered investments for which the securities are held by the counterparty's trust department or agent in the State's name. Category 3 includes uninsured and unregistered investments for which the securities are held by the counterparty, or by its trust department or agency but not in the State's name.

The CIFS account for the purchase and sale of investments using "trade date" accounting - investments are increased or decreased on the date the purchase or sales order is made although the investments are not received or delivered until a later date (settlement date). Thus, CIFS' investment schedule was prepared taking into account unsettled sales and purchases of investments. This means that investments under unsettled sales are included in the schedule, because the investments are still subject to custodial credit risk that could result in losses prior to settlement. Conversely, investments under unsettled purchases are excluded from the schedule, because the investments are still in the hands of the dealers.

Investment Type	Reported Amount Category 1	Fair Value
INVESTMENTS-PRIMARY GOVERNMENT SHORT-TERM INVESTMENT FUND (amounts in thousands)


Repurchase Agreements	$ 599,382	$ 599,382
Certificates of Deposit-Negotiable	432,424	432,615
Commercial Paper	1,551,232	1,551,235
Corporate Notes	13,001	13,004
Bankers' Acceptances	257,570	257,576
Federal Agency Securities	303,402	303,482
Student Loan-Backed Revolving Loans	17,903	17,903
State of Israel Bonds	1,500	1,500

Total Investments	$ 3,176,414	$ 3,176,697

INVESTMENTS-PRIMARY GOVERNMENT COMBINED INVESTMENT FUNDS (amounts in thousands)

	Reported Amount (Fair Value)
Investment Type	Category 1	Category 3	Total
Cash Equivalents	$ 862,059	$ 1,298,608	$ 2,160,667
Asset Backed Securities	453,925	-	453,925
U.S. Government and Agency Securities:
Not on Securities Loan	1,492,403	-	1,492,403
On Sec. Loan for Sec. or LOC Collateral	-	235,898	235,898
Mortgage Backed Securities	667,465	-	667,465
Corporate Debt	2,246,004	388,495	2,634,499
Convertible Securities	200,320	-	200,320
Common Stock:
Not on Securities Loan	9,056,539	-	9,056,539
On Sec. Loan for Sec. or LOC Collateral	-	34,746	34,746
Preferred Stock	163,887	-	163,887
	$ 15,142,602	$ 1,957,747	17,100,349
Investments not categorized because they are not evidenced by securities that exist in physical or book entry form:
Real Estate Investment Trusts			31,791
Mutual Funds			97,368
Limited Liability Corporations			29,495
Trusts			180,033
Limited Partnerships			790,042
Partnerships			49,501
Annuities			18,122
Securities Held by Brokers-Dealers under Sec. Loans for Cash Collateral:
U.S. Government and Agency Securities			552,731
Common Stock			1,071,472
International Fixed Securities			5,432
		$ 19,926,336
The pension trust funds own approximately 100% of the investments that are in categories 1 and 3.

INVESTMENTS-PRIMARY GOVERNMENT OTHER (amounts in thousands)

	Reported Amount
Investment Type	Category 1	Category 2	Category 3	Total	Fair Value
Collateralized Investment Agreements	$ 448,672	$ 100,846	$ -	$ 549,518	$ 549,779
State/Municipal Bonds	218,516	-	-	218,516	218,516
U.S. Government & Agency Securities	196,065	-	-	196,065	196,065
Repurchase Agreements	4,290	35,545	-	39,835	39,835
Annuity Contracts	589,394	-	-	589,394	589,394
Common Stock	21,735	977	1,312	24,024	24,024
Other	6,063	-	858	6,921	6,921
	$ 1,484,735	$ 137,368	$ 2,170	1,624,273	1,624,534
Investments not categorized because they are not evidenced by securities that exist in physical or book entry form:

Mutual Funds				93,460	93,460
Deferred Compensation Plan Mutual Investments				622,199	622,199
Tax Exempt Proceeds Fund				112,232	112,232
Other				23,888	23,888
Total Investments				$ 2,476,052	$ 2,476,313

The Connecticut Lottery Corp. owns approximately 40% and the Special Assessment fund owns approximately 99% of theinvestments that are in categories 1 and 2, respectively.

INVESTMENTS - COMPONENT UNITS (amounts in thousands)

	Reported Amount
Investment Type	Category 1	Category 2	Category 3	Total	Fair Value

U.S. Government & Agency Securities	$ 537,514	$ 76,575	$ 17,069	$ 631,158	$ 627,601
Common Stock	26,059	-	-	26,059	26,059
Repurchase Agreements	143,562	-	-	143,562	143,562
Collateralized Investment Agreements	2,848	-	18,863	16,015	18,863
Product Development and Marketing Investments	17,782	-	-	17,782	17,782
Mortgage Backed Securities	25,667	-	-	25,667	26,121
Corporate Bonds	18,171	-	-	18,171	18,552
Other	11,396	697	101	12,194	12,244
	$ 782,999	$ 77,272	$ 33,185	893,456	890,784
Investments not categorized because they are not evidenced by securities that exist in physical or book entry form:

Guaranteed Investment Contracts				404,731	404,731
Fidelity Funds				104,670	104,670
Limited Partnerships				2,259	2,259
Other				8,665	8,665
Total Investments				$ 1,413,781	$ 1,411,109
CHEFA owns 100% and CHESLA owns approximately 49% of the investments that are in categories 2 and 3, respectively.

Derivatives
GASB Technical Bulletin Number 94-1 defines deriv-atives as contracts whose value depends on, or derives from, the value of an underlying asset, reference rate, or index. According to this definition, the following State's investments or contracts are considered to be derivatives:

The State invests in derivatives in order to increase earnings on investments or to hedge against fluctuations in the value of foreign currencies (as in the case of foreign exchange contracts).

The Mutual Fixed Income Fund (a Combined Investment Fund) invests in collateralized mortgage obligations (CMOs) and asset backed securities (ABSs). These are bonds issued by a special purpose trust that collects payments on an underlying collateral pool of mortgages or other loans and remits payments to bondholders. The bonds are structured in a series of classes or tranches, each with a different coupon rate and stated maturity date. Interest payments to the bondholders are made in accordance with the trust indentures and amounts received from borrowers in excess of interest payments and expenses are used to amortize the principal on the bonds. Such principal payments are made to retire the tranches of bonds in order of their stated maturity. Because mortgage prepayments are largely dependent on market interest rates, the ultimate maturity date of the bonds is unpredictable and is sensitive to changes in market interest rates, but is generally prior to the stated maturity date. At June 30, 1998, the fund held CMOs of $610.9 million and ABSs of $152.9 million.

The Commercial Mortgage Fund (a Combined Investment Fund) investments in common stock include a subordinated residual interest in a securitized portfolio of commercial mortgage loans (the CMO residual). The single class of related senior bonds has been paid in full during the year. As of June 30, 1998, the CMO residual had an estimated fair value of $85.1 million.

Foreign exchange contracts are used to facilitate transactions in foreign securities and to manage the funds currency exposure. Contracts to buy are used to acquire exposure to foreign currencies, while contracts to sell are used to hedge the funds' investments against currency fluctuations. Losses may arise from changes in the value of foreign currencies or failure of the counterparties to perform under the contracts' terms.

Security Lending Transactions
Certain of the Combined Investment Funds are permitted by State statute to lend its securities through a lending agent to authorized broker-dealers and banks for collateral with a simultaneous agreement to return the collateral for the same securities in the future.

During the year, the funds' lending agent lent securities similar to the types on loan at year-end and received cash (United States and foreign currency), securities issued or guaranteed by the United States government, sovereign debt rated A or better, convertible bonds, and irrevocable bank letters of credit as collateral. The funds' lending agent did not have the ability to pledge or sell collateral securities delivered absent a borrower default. Borrowers were required to deliver collateral for each loan equal to: (1) in the case of loaned securities denominated in United States dollars or whose primary trading market was located in the United States or sovereign debt issued by foreign governments, 102% of the market value of the loaned securities; and (2) in the case of loaned securities not denominated in United States dollars or whose primary trading market was not located in the United States, 105% of the market value of the loaned securities. In the event any borrower fails to return the loaned securities or pay distributions thereon, the funds' lending agent is contractually obligated to purchase replacement securities, or return the cash collateral. At year end, the funds had no credit exposure to borrowers because the amounts the funds owed the borrowers exceeded the amounts the borrowers owed the funds.

All securities loans can be terminated on demand by either the funds or the borrowers. Cash collateral is invested in the lending agent's investment collateral pool, which at year-end had a weighted average maturity of 35 days. The weighted average duration of the loans was unknown, although it is assumed to remain at one day. A percentage of the investment collateral pool is invested in overnight instruments and money market mutual funds to enable it to meet normal liquidity needs.