CBOE Annual Report 2001

Basis of Presentation - The consolidated financial statements include the accounts and results of operations of the Exchange, and its wholly owned subsidiary, Chicago Options Exchange Building Corporation. Inter-company balances and transactions are eliminated.

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets and liabilities, disclosure of contingent assets and liabilities, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents - Cash and cash equivalents include highly liquid investments with maturities of three months or less from the date of purchase.

Investments - All investments are classified as available-for-sale and are reported at cost which approximates their fair value in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities."

Accounts Receivable - Accounts receivable consist primarily of transaction, marketing and other fees receivable from The Options Clearing Corporation ("OCC"), and the Exchange's share of distributable revenue receivable from The Options Price Reporting Authority ("OPRA").

Investments in Affiliates - Investments in affiliates represent investments in OCC and The Cincinnati Stock Exchange ("CSE"). The investment in OCC (20% of its outstanding stock) is carried at cost because of the limited percentage owned. The Exchange accounts for the investment in CSE (68% of its total certificates of proprietary membership) under the equity method due to the lack of effective control over the operating and financing activities of CSE.

Property and Equipment - Property and equipment are carried at cost. Depreciation on building, furniture and equipment is provided on the straight-line method. Estimated useful lives are 40 years for the building and five to ten years for furniture and equipment. Leasehold improvements are amortized over the lesser of their estimated useful lives or the remaining term of the applicable leases.

Data Processing Software - Data processing software is carried at cost and amortized over five to seven years using the straight-line method commencing with the date the software is put in service.

Goodwill - Goodwill is amortized over seven years to 40 years for financial statement presentation and over fifteen years for income tax purposes.

Impairment of Long-Lived Assets - Management reviews long-lived assets and the related intangible assets for impairment of value whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. If the Exchange determines it is unable to recover the carrying value of the assets, the assets will be written down using an appropriate method. Management does not believe current events or circumstances provide evidence that suggest asset values have been impaired.

Income Taxes - Income taxes are determined using the liability method, under which deferred tax assets and liabilities are recorded based on differences between the financial accounting and tax bases of assets and liabilities.

Other Deposits - Other deposits include amounts received from members for telephones in the Exchange facility and amounts for Exchange sponsored conferences.

Fair Value of Financial Instruments - SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of the fair value of certain financial instruments. The carrying values of financial instruments included in assets and liabilities are reasonable estimates of their fair value.

Adoption of New Accounting Policies - Effective for the fiscal year ended June 30, 2000, the Exchange adopted the American Institute of Certified Public Accountants' Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The statement requires capitalization of certain costs incurred in the development of internal-use software, including external direct material and service costs, employee payroll and payroll-related costs. Prior to adoption of SOP 98-1, the Exchange expensed these costs as incurred. The effect of this change in accounting principle was an increase to earnings, net of tax, of $7,531,700 and $9,483,000 for the fiscal years ended June 30, 2001 and 2000, respectively.

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires recognition of all derivative instruments in the balance sheet as either assets or liabilities and the measurement of those instruments at fair value. SFAS No. 133 also requires changes in the fair value of the derivative instruments to be recorded each period in current year earnings or comprehensive income depending on the intended use of the derivatives. In June 2000, the FASB issued SFAS No. 138, which amends the accounting and reporting standards of SFAS No. 133 for certain derivative instruments and certain hedging activities. SFAS No. 133 and SFAS No. 138 are required to be adopted by the Exchange effective July 1, 2001. In July 2001, the Exchange adopted the provisions of SFAS No. 133. No transition adjustment was required.

Recent Accounting Pronouncement - In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" which is effective for the Exchange July 1, 2002. Under SFAS No. 142, goodwill and separately identified intangible assets with indefinite lives will no longer be amortized but reviewed annually (or more frequently if impairment indicators arise) for impairment. Separately identified intangible assets not deemed to have indefinite lives will continue to be amortized over their useful lives. The Exchange has deemed the impact of adopting SFAS No. 142 to be immaterial.

The Exchange incurred rebillable expenses on behalf of CSE, for expenses such as employee costs, computer equipment and office space of $2,267,100 and $2,122,800 for the years ended June 30, 2001 and 2000, respectively. The Exchange had a receivable from CSE of $461,500 and $329,000 at June 30, 2001 and 2000, respectively.

OPRA is a committee administered jointly by the five options exchanges and is authorized by the Securities and Exchange Commission to provide consolidated options information. This information is provided by the exchanges and is sold to outside news services and customers. OPRA's operating income is distributed among the exchanges based on their relative volume of total transactions. Operating income distributed to the Exchange was $21,538,600 and $22,580,700 for the years ended June 30, 2001 and 2000, respectively. The Exchange had a receivable from OPRA of $5,614,700 and $5,789,500 at June 30, 2001 and 2000, respectively.

Eligible employees participate in the Supplemental Employee Retirement Plan (the "SERP Plan"). The SERP Plan is a defined contribution plan that is nonqualified by Internal Revenue Code regulations. The Exchange contributed $1,128,400 and $1,256,200 to the SERP Plan for the years ended June 30, 2001 and 2000, respectively.

The Exchange also has a Voluntary Employees' Beneficiary Association ("VEBA"). The VEBA is a trust, qualifying under Internal Revenue Code Section 501(c)(9), created to provide certain medical, dental, severance, and short-term disability benefits to employees of the Exchange. Contributions to the trust are based on reserve levels established by Section 419(a) of the Internal Revenue Code. During fiscal years 2001 and 2000, the Exchange contributed $1,704,700 and $967,700, respectively, to the trust.

In September 2000, the Exchange reached an agreement in principle to settle a consolidated civil class action lawsuit filed against the Exchange and the other U.S. options exchanges and certain market maker firms. The Exchange agreed to pay $16.0 million in three equal installments on or before October 16, 2000, July 1, 2001, and July 1, 2002. Two payments totaling $10.7 million were made in fiscal year 2001, and are being held in escrow pending approval of the settlement agreement by the U.S. District Court for the Southern District of New York. Approval of the settlement agreement is currently pending appellate review of the district court's February 2001 order granting summary judgment in favor of the defendants.

In May 2001, the Exchange and the Chicago Mercantile Exchange, Inc. announced plans to create a joint venture to trade single-stock futures. The Exchange has a 41.6% stake in the joint venture. The new entity will be a for-profit company, will have its own management and board, and will be separately organized as a regulated exchange. As of September 2001, the Exchange has committed $1.3 million in funding for the joint venture.

A reconciliation of the statutory federal income tax rate to the effective income tax rate, for the years ended June 30, 2001 and 2000, is as follows:

The Exchange also has been sued by three individuals who describe themselves as retail customers and who claim that the manner in which the Exchange operated its "electronic transfer system" violated certain provisions of the Securities Exchange Act of 1934 and the antitrust laws and breached contracts that the Exchange supposedly had with plaintiffs. Plaintiffs also allege that the Exchange's regulatory inquiry interfered with plaintiffs' contractual relations with their clearing firms. The complaint seeks damages in excess of $75,000, plus treble damages in connection with the antitrust claims, pre- and post-judgment interest, costs, and attorneys' fees.

The Exchange believes that it has meritorious defenses and intends to vigorously defend itself against these actions. However, the Exchange cannot presently estimate the amount of loss, if any, that may result. The ultimate outcome of these cases cannot presently be determined and no allowance for loss that may result has been made in these financial statements.