The sleepy derivatives market could get a wake-up call over the next week, as California sells $7 billion of short-term securities. The California securities are expected to provide fertile ground for derivatives dealers.

Today's scheduled $4 billion issue of revenue anticipation warrants will be sold competitively without primary market derivatives. But the warrants, which mature in 22 months, will be snapped up by firms hoping to create secondary market derivatives. Despite the state's recent credit woes, demand for secondary market derivatives based on California paper remains strong, market sources said.

Next week, the state will sell $3 billion of revenue anticipation notes due in 11 months. About $750 million to $1 billion of the deal may be sold in the primary market as indexed floating-rate notes.

Such securities pay a floating rate based on a particular index. The California Rans may be linked to a constant maturity Treasury rate, the London Interbank Offered Rate, or the Public Securities Association's municipal swap index.

The state would then enter a swap to lock in a synthetic fixed rate on the indexed Rans.

But market sources said yesterday that synthetic fixed-rate structures are not achieving substantial savings in the current market. "Right now, I don't think we'll see anything," one derivatives professional said. "The market could change by next week, but I think it's unlikely."

Last summer's California note deal included the first issue of indexed notes, designed by Goldman, Sachs & Co. and based on the PSA rate.

Indexed securities are appealing to money market funds, but unlike other types of short-term securities, they do not require credit enhancement.

The funds must keep an average maturity of less than 90 days and cannot hold a security with a maturity of more than 13 months. Under the laws governing the funds, an indexed security can be deemed to mature on each reset date instead of the final maturity.

Remarketed floating-rate securities, such as tender option bonds, require credit enhancement such as a liquidity agreement or a put agreement to allow the funds to count the reset date as the maturity

If the tax-exempt indexed securities are based on a taxable index, they will pay only a portion of the index. For example, the securities might pay 70% of the London Interbank Offered Rate, since the equivalent tax-exempt short4erm rate is only 70% of Libor.

That appeals to investors expecting the ratios to change. If the tax-exempt market outperforms the taxable market, for example, the ratio may fall to 60% from 70%, but the investor has locked in the 70% ratio on the notes.

Investors holding ordinary tax-exempt floating-rate paper will see their yields drop more than the holder of the 70% Libor floating-rate security.

Another major issuer, the Intermountain Power Agency in Utah, is considering using derivatives structures later this year. The agency has outstanding debt that cannot be advance refunded, so several firms have proposed synthetic refundings using swaps or options. Agency officials will consider the proposals over the summer and could be ready for a deal in the fall.

The power agency has signed master swap agreements with Goldman Sachs, Lehman Brothers, Merrill Lynch & Co., and J.P. Morgan Securities and is negotiating an agreement with CS First Boston.

With the agreements in place, agency officials hope to be able to quickly execute swaps with the firms. Having five swap counterparties available will allow the agency to diversify its credit exposure and get competitive pricing, one official said.

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