UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1999 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File No. 0-17446 DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. (Exact name of registrant as specified in its charter) Delaware 13-3490286 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) c/o Demeter Management Corporation Two World Trade Center, 62 Fl., New York, NY 10048 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 392-5454 (Former name, former address, and former fiscal year, if changed since last report) Indicate by check-mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. INDEX TO QUARTERLY REPORT ON FORM 10-Q June 30, 1999 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Statements of Financial Condition June 30, 1999 (Unaudited) and December 31, 1998.....................2 Statements of Operations for the Quarters Ended June 30, 1999 and 1998 (Unaudited)....................3 Statements of Operations for the Six Months Ended June 30, 1999 and 1998 (Unaudited)....................4 Statements of Changes in Partners' Capital for the Six Months ended June 30, 1999 and 1998 (Unaudited)...........................................5 Statements of Cash Flows for the Six Months Ended June 30, 1999 and 1998 (Unaudited)....................6 Notes to Financial Statements (Unaudited)..........7-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..12-21 Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................21-32 Part II. OTHER INFORMATION Item 1. Legal Proceedings.............................. 33 Item 6. Exhibits and Reports on Form 8-K............... 33 PART I. FINANCIAL INFORMATION Item 1. Financial Statements DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF FINANCIAL CONDITION June 30, December 31, 1999 1998 $ $ (Unaudited) ASSETS Equity in futures interests trading accounts: Cash 9,008,090 10,606,680 Net unrealized gain on open contracts 388,544 206,564 Total Trading Equity 9,396,634 10,813,244 Interest receivable (DWR) 28,254 32,410 Total Assets 9,424,888 10,845,654 LIABILITIES AND PARTNERS' CAPITAL Liabilities Redemptions payable 363,068 239,703 Accrued management fees (DWFCM) 23,562 27,114 Accrued incentive fee (DWFCM) - 3,871 Total Liabilities 386,630 270,688 Partners' Capital Limited Partners (3,315.777 and 3,640.082 Units, respectively) 8,763,392 10,281,223 General Partner (104 Units) 274,866 293,743 Total Partners' Capital 9,038,258 10,574,966 Total Liabilities and Partners' Capital 9,424,888 10,84 5,654 NET ASSET VALUE PER UNIT 2,642.94 2,824.45 <FN> The accompanying notes are an integral part of these financial statements. DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF OPERATIONS (Unaudited) For the Quarters Ended June 30, 1999 1998 $ $ REVENUES Trading profit (loss): Realized 37,455 (908,805) Net change in unrealized 88,003 1,237,965 Total Trading Results 125,458 329,160 Interest Income (DWR) 83,860 103,795 Total Revenues 209,318 432,955 EXPENSES Brokerage commissions (DWR) 158,925 171,358 Management fees (DWFCM) 71,618 79,654 Transaction fees and costs 11,267 12,280 Incentive fee (DWFCM) 3,324 - Total Expenses 245,134 263,292 NET INCOME (LOSS) (35,816) 169,663 NET INCOME (LOSS) ALLOCATION Limited Partners (34,769) 165,446 General Partner(1,047) 4,217 NET INCOME (LOSS) PER UNIT Limited Partners (10.07) 40.55 General Partner (10.07) 40.55 <FN> The accompanying notes are an integral part of these financial statements. DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF OPERATIONS (Unaudited) For the Six Months Ended June 30, 1999 1998 $ $ REVENUES Trading profit (loss): Realized (557,135) 608,863 Net change in unrealized 181,980 (718,931) Total Trading Results (375,155) (110,068) Interest Income (DWR) 173,149 213,678 Total Revenues (202,006) 103,610 EXPENSES Brokerage commissions (DWR) 308,856 339,598 Management fees (DWFCM) 147,426 163,260 Transaction fees and costs 23,135 26,844 Incentive fee (DWFCM) (3,716) - Total Expenses 475,701 529,702 NET LOSS (677,707) (426,092) NET LOSS ALLOCATION Limited Partners (658,830) (415,831) General Partner (18,877) (10,261) NET LOSS PER UNIT Limited Partners (181.51) (98.66) General Partner (181.51) (98.66) <FN> The accompanying notes are an integral part of these financial statements. DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF CHANGES IN PARTNERS' CAPITAL For the Six Months Ended June 30, 1999 and 1998 (Unaudited) Units of Partnership Limited General Interest Partners Partner Total Partners' Capital, December 31, 1997 4,279.580 $11,209,045 $279,181 $11,488,226 Net Loss - (415,831) (10,261) (426,092) Redemptions (272.142) (699,803) - (699,803) Partners' Capital, June 30, 1998 4,007.438 $10,093,411 $268,920 $10,362,331 Partners' Capital, December 31, 1998 3,744.082 $10,281,223 $293,743 $10,574,966 Net Loss - (658,830) (18,877) (677,707) Redemptions (324.305) (859,001) - (859,001) Partners' Capital, June 30, 1999 3,419.777 $8,763,392 $274,866 $9,038,258 <FN> The accompanying notes are an integral part of these financial statements. DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. STATEMENTS OF CASH FLOWS (Unaudited) For the Six Months Ended June 30, 1999 1998 $ $ CASH FLOWS FROM OPERATING ACTIVITIES Net loss (677,707) ( 426,092) Noncash item included in net loss: Net change in unrealized (181,980) 718,931 (Increase) decrease in operating assets: Interest receivable (DWR) 4,156 3,354 Due from DWR - (11,835) Decrease in operating liabilities: Accrued management fees (DWFCM) (3,552) (2,391) Accrued incentive fee (DWFCM) (3,871) - - Net cash provided by (used for) operating activities (862,954) 281,967 CASH FLOWS FROM FINANCING ACTIVITIES Increase in redemptions payable 123,365 172,019 Redemptions of units (859,001) (699,803) Net cash used for financing activities (735,636) (527,784) Net decrease in cash (1,598,590) ( 245,817) Balance at beginning of period 10,606,680 10,015,151 Balance at end of period 9,008,090 9,769,334 <FN> The accompanying notes are an integral part of these financial statements. DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) The financial statements include, in the opinion of management, all adjustments necessary for a fair presentation of the results of operations and financial condition of Dean Witter Diversified Futures Fund II L.P. (the "Partnership"). The financial statements and condensed notes herein should be read in conjunction with the Partnership's December 31, 1998 Annual Report on Form 10-K. 1. Organization Dean Witter Diversified Futures Fund II L.P. is a limited partnership organized to engage primarily in the speculative trading of commodity futures and forward contracts, physical commodities, and other commodity interests (collectively, "futures interests"). The general partner for the Partnership is Demeter Management Corporation ("Demeter"). The non-clearing commodity broker is Dean Witter Reynolds Inc. ("DWR") and an unaffiliated clearing commodity broker, Carr Futures Inc. ("Carr"), provides clearing and execution services. The trading manager is Dean Witter Futures & Currency Management Inc. ("DWFCM" or the "Trading Manager"). Demeter, DWR and DWFCM are wholly-owned subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW"). DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 2. Related Party Transactions The Partnership's cash is on deposit with DWR and Carr in futures interests trading accounts to meet margin requirements as needed. DWR pays interest on these funds based on current 13-week U.S. Treasury bills. The Partnership pays brokerage commissions to DWR. Management fees and incentive fees (if any) incurred by the Partnership are paid to DWFCM. 3. Financial Instruments The Partnership trades commodity futures and forward contracts, physical commodities, and other commodity interests. Futures and forwards represent contracts for delayed delivery of an instrument at a specified date and price. Risk arises from changes in the value of these contracts and the potential inability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" effective for fiscal years beginning after June 15, 1999. The Partnership elected to adopt the provisions of SFAS No. 133 beginning with the fiscal year that ended December 31, 1998. SFAS No. 133 supersedes SFAS No. 119 and No. 105, which required the DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) disclosure of average aggregate fair values and contract/notional values, respectively, of derivative financial instruments for an entity which carries its assets at fair value. The application of SFAS No. 133 does not have a significant effect on the Partnership's financial statements. The net unrealized gain on open contracts is reported as a component of "Equity in futures interests trading accounts" on the Statements of Financial Condition and totaled $388,544 and $206,564 at June 30, 1999 and December 31, 1998, respectively. Of the $388,544 net unrealized gain on open contracts at June 30, 1999, $330,111 related to exchange-traded futures contracts and $58,433 related to off-exchange-traded forward currency contracts. Of the $206,564 net unrealized gain on open contracts at December 31, 1998, $596,320 related to exchange-traded futures contracts and $(389,756) related to off-exchange-traded forward currency contracts. Exchange-traded futures contracts held by the Partnership at June 30, 1999 and December 31, 1998 mature through December 1999 and June 1999, respectively. Off-exchange-traded forward currency contracts held by the Partnership at June 30, 1999 and December DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. NOTES TO FINANCIAL STATEMENTS - (CONTINUED) 31, 1998 mature through September 1999 and April 1999, respectively. The Partnership is subject to the credit risk associated with counterparty non-performance. The credit risk associated with the instruments in which the Partnership is involved is limited to the amounts reflected in the Partnership's Statements of Financial Condition. DWR and Carr act as the futures commission merchants or the counterparties with respect to most of the Partnership's assets. Exchange-traded futures contracts are marked to market on a daily basis, with variations in value settled on a daily basis. Each of DWR and Carr, as a futures commission merchant for all of the Partnership's exchange-traded futures contracts, are required, pursuant to regulations of the Commodity Futures Trading Commission ("CFTC") to segregate from their own assets, and for the sole benefit of their commodity customers, all funds held by them with respect to exchange-traded futures contracts, including an amount equal to the net unrealized gain on all open futures contracts, which funds, in the aggregate, totaled $9,338,201 and $11,203,000 at June 30, 1999 and December 31, 1998, respectively. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily settlements of variations in value nor is there any requirement that an amount equal to the DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. NOTES TO FINANCIAL STATEMENTS - (CONCLUDED) net unrealized gain on open forward contracts be segregated. With respect to those off-exchange-traded forward currency contracts, the Partnership is at risk to the ability of Carr, the sole counterparty on all of such contracts, to perform. Carr's parent, Credit Agricole Indosuez, has guaranteed to the Partnership payment of the net liquidating value of the transactions in the Partnership's account with Carr (including foreign currency contracts). Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity - Assets of the Partnership are deposited with DWR as non-clearing broker and Carr as clearing broker in separate futures interest trading accounts. Such assets are held in either non-interest bearing bank accounts or in securities approved by the CFTC for investment of customer funds. The Partnership's assets held by DWR and Carr may be used as margin solely for the Partnership's trading. Since the Partnership's sole purpose is to trade in futures interests, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in futures interests may, from time to time, be illiquid. Most United States futures exchanges limit fluctuations in certain futures interest prices during a single day by regulations referred to as "daily price fluctuations limits" or "daily limits". Pursuant to such regulations, during a single trading day no trades may be executed at prices beyond the daily limit. If the price for a particular futures interest has increased or decreased by an amount equal to the daily limit, positions in such futures interest can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Futures interests prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its futures interests and result in restrictions on redemptions. There is no limitation on daily price moves in trading forward contracts on foreign currency. The markets for some world currencies have low trading volume and are illiquid, which may prevent the Partnership from trading in potentially profitable markets or from promptly liquidating unfavorable positions, subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions. Capital Resources. The Partnership does not have, nor does it expect to have, any capital assets. Future redemptions of Units of Limited Partnership Interest ("Unit(s)") will affect the amount of funds available for investment in futures interests in subsequent periods. Since they are at the discretion of Limited Partners, it is not possible to estimate the amount and therefore, the impact of future redemptions. Results of Operations For the Quarter and Six Months Ended June 30, 1999 For the quarter ended June 30, 1999, the Partnership recorded total trading revenues including interest income of $209,318 and, after expenses, posted a decrease in Net Asset Value per Unit. The most significant net trading losses were experienced in the metals markets from long positions in copper and aluminum futures as base metals prices declined significantly during late May amid large supply, low demand and the possibility of a production cut in the near future being judged unlikely. During June, additional losses were incurred in this market complex from short copper futures positions as prices moved higher due to a drop in warehouse stocks. In the global stock index futures markets, losses were recorded during mid-April and May from long S&P 500 Index futures positions as domestic equity prices dropped following stronger-than-expected Consumer Price Index data and indications by the Federal Open Market Committee that the U.S. Federal Reserve is shifting towards a tightening bias. In the agricultural markets, losses were experienced from long corn futures positions as prices regressed in early April in reaction to reports by the USDA that the expected corn surplus will be one of the biggest in years and from declining demand in the Asian markets. These losses were partially offset by gains recorded in the currency markets during April and May from short Swedish kroner positions as its value weakened versus the U.S. dollar on speculation as to when Sweden will join Europe's Monetary Union and due to a decline in oil prices. In the global interest rate futures markets, gains were recorded from long Japanese government bonds as prices rallied during April after the Japanese government proposed no new economic spending plans and on comments by a Senior Finance Ministry official that the supply- demand balance in the market will deteriorate. In soft commodities, gains were recorded from short cotton futures positions as prices dropped in late June on reports of beneficial rainfalls across the Southeastern U.S. In the energy markets, gains were recorded during April from long natural gas futures positions as prices climbed following reports of an increase in storage stocks that was well-below market expectations. Total expenses for the three months ended June 30, 1999 were $245,134, resulting in a net loss of $35,816. The value of a Unit decreased from $2,653.01 at March 31, 1999 to $2,642.94 at June 30, 1999. For the six months ended June 30, 1999, the Partnership recorded total trading losses net of interest income of $202,006 and posted a decrease in Net Asset Value per Unit. The most significant losses were experienced in the metals markets from long positions in copper and zinc futures as base metals prices declined significantly in late May amid large supply, low demand and the possibility of a production cut in the near future being judged unlikely. During June, additional losses were incurred in this market complex from short copper futures positions as prices moved higher due to a drop in warehouse stocks. In the global interest rate futures markets, losses were recorded throughout a majority of the first quarter from short Japanese bond futures positions as prices increased amid growing speculation that the Bank of Japan may underwrite Japanese government bonds. Fears that a rise in Japanese bond yields would lead many Japanese money managers to repatriate assets from foreign investments to yen-denominated debt also pushed prices higher. Additional losses were recorded during February and March from short German government bond futures positions as prices increased on reports that Germany's industrial production showed a sharp increase, creating hopes that Europe's biggest economy could be strengthening. In the currency markets, losses were experienced throughout a majority of the first quarter from long Australian dollar positions as its value dropped significantly relative to the U.S. dollar on speculation regarding potential currency devaluations in the Asian region. Losses recorded from short British pound positions in March offset profits recorded in February as its value strengthened versus the U.S. dollar as the market scaled back the chances of a British interest rate cut following an announcement of a budget that was more generous than expected. In the global stock index futures markets, losses were experienced during February, mid-April and May from long S&P 500 Index futures positions as domestic equity prices moved lower on concerns that the Federal Reserve may raise interest rates in an effort to control inflation, following stronger-than-expected Consumer Price Index data and on indications by the Federal Open Market Committee that the U.S. Federal Reserve is shifting towards a tightening bias. These losses were partially offset by gains recorded in the energy markets during March from long positions in crude and heating oil futures as prices moved significantly higher on news that both OPEC and non-OPEC countries had reached an agreement to cut total output by approximately two million barrels a day beginning April 1st. Total expenses for the six months ended June 30, 1999 were $475,701, resulting in a net loss of $677,707. The value of a Unit decreased from $2,824.45 at December 31, 1998 to $2,642.94 at June 30, 1999. For the Quarter and Six Months Ended June 30, 1998 For the quarter ended June 30, 1998, the Partnership recorded total trading revenues including interest income of $432,955, and posted an increase in Net Asset Value per Unit. The most significant gains were recorded in the currency markets during May from short Japanese yen positions as the value of the yen reached its lowest level relative to the U.S. dollar since 1991. Additional gains were recorded during June from short South African rand positions as its value also trended lower versus the U.S. dollar despite intervention by the South African government. Currency gains were also recorded from trading the Swedish krona and Australian dollar throughout the quarter. In soft commodities, gains were recorded from short coffee futures positions as prices moved lower during April and June. Smaller gains were recorded during the second quarter in the agricultural and metals markets from short positions in corn, wheat and aluminum futures. A portion of these gains was offset by losses in the financial futures markets during April and June. In April, losses were recorded from long global bond futures positions as Australian, Japanese and European interest rate futures prices reversed lower after trending higher previously. The previous trend higher in global interest rate futures prices re-emerged during May. However, additional losses were recorded during June as this upward move reversed sharply lower during mid- month in reaction to the Federal Reserve's intervention to halt the downward slide of the Japanese yen. Additional losses were recorded from trading global stock index futures during April and June. Smaller losses were recorded in the energy markets from short natural gas futures positions as prices reversed higher during June after trending lower previously. Total expenses for the three months ended June 30, 1998 were $263,292, resulting in net income of $169,663. The value of a Unit increased from $2,545.22 at March 31, 1998 to $2,585.77 at June 30, 1998. For the six months ended June 30, 1998, the Partnership recorded total trading revenues including interest income of $103,610 and after expenses posted a decrease in Net Asset Value per Unit. The most significant net trading losses were recorded in the metals markets during the first quarter from long silver futures positions as silver prices reversed lower in February after rallying higher during January. Additional losses were recorded from trading gold futures during much of the first half of the year. Smaller losses were recorded from trading base metals futures during March and May. In financial futures, losses recorded during the second quarter from short Nikkei Index futures positions, as well as from long Australian bond futures positions more than offset profits recorded during the first quarter from long European bond futures positions. In currency trading, significant losses recorded during the first quarter due primarily to short-term volatility in the value of the Japanese yen were offset during the second quarter by gains from short Japanese yen positions as its value moved dramatically lower during May. Additional currency gains recorded in the second quarter from trading the Swedish krona and South African Rand offset losses recorded in European currencies during the first six months of the year. Additionally, trendless movement in soybean futures prices during January and March resulted in smaller losses for the Partnership. A portion of the Partnership's overall losses for the first half of the year was offset by gains in soft commodities recorded from short sugar futures positions as prices trended lower during January and February and from short coffee futures positions as prices trended lower during April and June. Total expenses for the six months ended June 30, 1998 were $529,702, resulting in a net loss of $426,092. The value of a Unit decreased from $2,684.43 at December 31, 1997 to $2,585.77 at June 30, 1998. Year 2000 Problem. Commodity pools, like financial and business organizations and individuals around the world, depend on the smooth functioning of computer systems. Many computer systems in use today cannot recognize the computer code for the year 2000, but revert to 1900 or some other date. This is commonly known as the "Year 2000 Problem". The Partnership could be adversely affected if computer systems used by it or any third party with whom it has a material relationship do not properly process and calculate date-related information and data concerning dates on or after January 1, 2000. Such a failure could adversely affect the handling or determination of futures trades and prices and other services. MSDW began its planning for the Year 2000 Problem in 1995, and currently has several hundred employees working on the matter. It has developed its own Year 2000 compliance plan to deal with the problem and had the plan approved by the company's executive management, Board of Directors and Information Technology Department. Demeter is coordinating with MSDW to address the Year 2000 Problem with respect to Demeter's computer systems that affect the Partnership. This includes hardware and software upgrades, systems consulting and computer maintenance. Beyond the challenge facing internal computer systems, the systems failure of any of the third parties with whom the Partnership has a material relationship - the futures exchanges and clearing organizations through which it trades, Carr, or the Trading Manager - could result in a material financial risk to the Partnership. All U.S. futures exchanges are subject to monitoring by the CFTC of their Year 2000 preparedness and the major foreign futures exchanges are also expected to be subject to market-wide testing of their Year 2000 compliance during 1999. Demeter intends to monitor the progress of Carr and the Trading Manager throughout 1999 in their Year 2000 compliance and, where applicable, to test its external interface with Carr and the Trading Manager. A worst case scenario would be one in which trading of contracts on behalf of the Partnership becomes impossible as a result of the Year 2000 problem encountered by any third parties. A less catastrophic but more likely scenario would be one in which trading opportunities diminish as a result of technical problems resulting in illiquidity and fewer opportunities to make profitable trades. MSDW has begun developing various "contingency plans" in the event that the systems of such third parties fail. Demeter intends to consult closely with MSDW in implementing those plans. Despite the best efforts of both Demeter and MSDW, however, it is possible that these steps will not be sufficient to avoid any adverse impact to the Partnership. Risks Associated With the Euro. On January 1, 1999, eleven countries in the European Union established fixed conversion rates on their existing sovereign currencies and converted to a common single currency (the "euro"). During a three-year transition period, the sovereign currencies will continue to exist but only as a fixed denomination of the euro. Conversion to the euro prevents the Trading Manager from trading in certain currencies and thereby limits its ability to take advantage of potential market opportunities that might otherwise have existed had separate currencies been available to trade. This could adversely affect the performance results of the Partnership. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction The Partnership is a commodity pool engaged primarily in the speculative trading of futures interests. The market sensitive instruments held by the Partnership are acquired solely for speculative trading purposes and, as a result, all or substantially all of the Partnership's assets are subject to the risk of trading loss. Unlike an operating company, the risk of market sensitive instruments is integral, not incidental, to the Partnership's primary business activities. The futures interests traded by the Partnership involve varying degrees of related market risk. Such market risk is often dependent upon changes in the level or volatility of interest rates, exchange rates, and/or market values of financial instruments and commodities. Fluctuations in related market risk based upon the aforementioned factors result in frequent changes in the fair value of the Partnership's open positions, and, consequently, in its earnings and cash flow. The Partnership's total market risk is influenced by a wide variety of factors, including the diversification effects among the Partnership's existing open positions, the volatility present within the market(s), and the liquidity of the market(s). At varying times, each of these factors may act to exacerbate or mute the market risk associated with the Partnership. The Partnership's past performance is not necessarily indicative of its future results. Any attempt at quantifying the Partnership's market risk must be qualified by the inherent uncertainty of its speculative trading, which may cause future losses and volatility (i.e. "risk of ruin") far in excess of the Partnership's experience to date and/or any reasonable expectation premised upon historical changes in the fair value of its market sensitive instruments. Quantifying the Partnership's Trading Value at Risk The following quantitative disclosures regarding the Partnership's market risk exposures contain "forward-looking statements" within the meaning of the safe harbor from civil liability provided for such statements by the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). All quantitative disclosures in this section are deemed to be forward- looking statements for purposes of the safe harbor, except for statements of historical fact. The Partnership accounts for open positions on the basis of mark- to-market accounting principles. As such, any loss in the fair value of the Partnership's open positions is directly reflected in the Partnership's earnings, whether realized or unrealized, and the Partnership's cash flow, as profits and losses on open positions of exchange-traded futures interests are settled daily through variation margin. The Partnership's risk exposure in the various market sectors traded by the Trading Manager is estimated below in terms of Value at Risk ("VaR"). The VaR model employed by the Partnership incorporates numerous variables that could impact the fair value of the Partnership's trading portfolio. The Partnership estimates VaR using a model based on historical simulation with a confidence level of 99%. Historical simulation involves constructing a distribution of hypothetical daily changes in trading portfolio value. The VaR model generally takes into account linear exposures to price and interest rate risk. Market risks that are incorporated in the VaR model include equity and commodity prices, interest rates, foreign exchange rates, as well as correlation that exists among these variables. The hypothetical changes in portfolio value are based on daily observed percentage changes in key market indices or other market factors ("market risk factors") to which the portfolio is sensitive. In the case of the Partnership's VaR, the historical observation period is approximately four years. The Partnership's one-day 99% VaR corresponds to the negative change in portfolio value that, based on observed market risk factor moves, would have been exceeded once in 100 trading days. VaR models such as the Partnership's are continually evolving as trading portfolios become more diverse and modeling techniques and systems capabilities improve. It must also be noted that the VaR model is used to quantify market risk for historic reporting purposes only and is not utilized by either Demeter or the Trading Manager in their daily risk management activities. The Partnership's Value at Risk in Different Market Sectors The following table indicates the VaR associated with the Partnership's open positions as a percentage of total Net Assets by market category as of June 30, 1999. As of June 30, 1999, the Partnership's total capitalization was approximately $9 million. Primary Market June 30, 1999 Risk Category Value at Risk Currency (1.94)% Interest Rate (1.93) Equity (0.50) Commodity (0.93) Aggregate Value at Risk (3.12)% Aggregate value at risk represents the aggregate VaR of the Parntership's open positions and not the sum of the VaR of the individual categories listed above. Aggregate VaR will be lower as it takes into account correlation among different positions and categories. The table above represents the VaR of the Partnership's open positions at June 30, 1999 only and is not necessarily representative of either the historic or future risk of an investment in the Partnership. As the Partnership's sole business is the speculative trading of primarily futures interests, the composition of its portfolio of open positions can change significantly over any given time period or even within a single trading day. Such changes in open positions could materially impact market risk as measured by VaR either positively or negatively. The table below supplements the quarter-end VaR by presenting the Partnership's high, low and average VaR as a percentage of total Net Assets for the four quarterly reporting periods from July 1, 1998 through June 30, 1999. Primary Market Risk Category High Low Average Currency (2.02)% (0.96)% (1.72)% Interest Rate (1.93) (0.47) (1.26) Equity (0.74) (0.18) (0.43) Commodity (1.12) (0.66) (0.94) Aggregate Value at Risk (3.12)% (1.37)% (2.38)% Limitations on Value at Risk as an Assessment of Market Risk The face value of the market sector instruments held by the Partnership is typically many times the applicable margin require- ments, as such margin requirements generally range between 2% and 15% of contract face value. Additionally, due to the use of leverage, the face value of the market sector instruments held by the Partnership is typically many times the total capitalization of the Partnership. The financial magnitude of the Partnership's open positions thus creates a "risk of ruin" not typically found in other investment vehicles. Due to the relative size of the positions held, certain market conditions may cause the Partnership to incur losses greatly in excess of VaR within a short period of time. The foregoing VaR tables, as well as the past performance of the Partnership, gives no indication of such "risk of ruin". In addition, VaR risk measures should be interpreted in light of the methodology's limitations, which include the following: past changes in market risk factors will not always yield accurate predictions of the distributions and correlations of future market movements; changes in portfolio value in response to market movements may differ from the responses implicit in a VaR model; published VaR results reflect past trading positions while future risk depends on future positions; VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day; and the historical market risk factor data used for VaR estimation may provide only limited insight into losses that could be incurred under certain unusual market movements. The foregoing VaR tables present the results of the Partnership's VaR for each of the Partnership's market risk exposures and on an aggregate basis at June 30, 1999 and for the end of the four quarterly reporting periods from July 1, 1998 through June 30, 1999. Since VaR is based on historical data, VaR should not be viewed as predictive of the Partnership's future financial performance or its ability to manage and monitor risk and there can be no assurance that the Partnership's actual losses on a particular day will not exceed the VaR amounts indicated or that such losses will not occur more than 1 in 100 trading days. Non-Trading Risk The Partnership has non-trading market risk on its foreign cash balances not needed for margin. However, such balances, as well as any market risk they may represent, are immaterial. The Partnership also maintains a substantial portion (approximately 85%) of its available assets in cash at DWR. A decline in short- term interest rates will result in a decline in the Partnership's cash management income. This cash flow risk is not considered material. Materiality, as used throughout this section, is based on an assessment of reasonably possible market movements and the potential losses caused by such movements, taking into account the leverage, optionality and multiplier features of the Partnership's market sensitive instruments. Qualitative Disclosures Regarding Primary Trading Risk Exposures The following qualitative disclosures regarding the Partnership's market risk exposures - except for (i) those disclosures that are statements of historical fact and (ii) the descriptions of how the Partnership manages its primary market risk exposures - constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. The Partnership's primary market risk exposures as well as the strategies used and to be used by Demeter and the Trading Manager for managing such exposures are subject to numerous uncertainties, contingencies and risks, any one of which could cause the actual results of the Partnership's risk controls to differ materially from the objectives of such strategies. Government interventions, defaults and expropriations, illiquid markets, the emergence of dominant fundamental factors, political upheavals, changes in historical price relationships, an influx of new market participants, increased regulation and many other factors could result in material losses as well as in material changes to the risk exposures and the risk management strategies of the Partnership. Investors must be prepared to lose all or substantially all of their investment in the Partnership. The following were the primary trading risk exposures of the Partnership as of June 30, 1999, by market sector. It may be anticipated however, that these market exposures will vary materially over time. Currency. The primary trading risk exposure in the Partnership is in the currency complex. The Partnership's currency exposure is to exchange rate fluctuations, primarily fluctuations that disrupt the historical pricing relationships between different currencies and currency pairs. Interest rate changes as well as political and general economic conditions influence these fluctuations. The Partnership trades in a large number of currencies, including cross- rates i.e., positions between two currencies other than the U.S. dollar. For the second quarter of 1999, the Partnership's major exposures were in the Euro currency crosses and outright US dollar positions (outright positions consists of the U.S. dollar vs. other currencies. These other currencies include the major and minor currencies). Demeter does not anticipate that the risk profile of the Partnership's currency sector will change significantly in the future. The currency trading VaR figure includes foreign margin amounts converted into U.S. dollars with an incremental adjustment to reflect the exchange rate risk inherent to the dollar-based Partnership in expressing VaR in a functional currency other than dollars. Interest Rate. The second largest trading risk exposure this quarter was in the interest rate sector. Exposure was spread across the U.S., European, Swiss, Australian, and Japanese interest rate sectors. Interest rate movements directly affect the price of the sovereign bond futures positions held by the Partnership and indirectly affect the value of its stock index and currency positions. Interest rate movements in one country as well as relative interest rate movements between countries materially impact the Partnership's profitability. The Partnership's primary interest rate exposure is generally to interest rate fluctuations in the G-7 countries and Australia. Demeter anticipates that G-7 and Australian interest rates will remain the primary interest rate exposure of the Partnership for the foreseeable future. The changes in interest rates which have the most effect on the Partnership are changes in long-term and medium-term instruments. Consequently, even a material change in short-term rates would have little effect on the Partnership, were the medium to long term rates to remain steady. Equity. The Partnership's equity trading risk exposure on June 30, 1999 was limited to price risk in the Nikkei index (Japan). The stock index futures traded by the Partnership are by law limited to futures on broadly based indices. Demeter anticipates little, if any, trading in non G-7 stock indices. The Partnership is primarily exposed to the risk of adverse price trends or static markets in the U.S. and Japanese indices. (Static markets would not cause major market changes but would make it difficult for the Partnership to avoid being "whipsawed" into numerous small losses). Commodity. Metals. The next largest exposure at June 30, 1999 was in the base and precious metals markets. The Partnership aims to equally weight market exposure in the metals as much as possible, however, base metals, during period of volatility, will affect performance more dramatically than the precious metals markets. Demeter anticipates that the base metals will remain the primary metals market exposure of the Partnership. Energy. On June 30, 1999, the Partnership's energy exposure was shared by futures contracts in the NY and London crude oil futures markets. Price movements in these markets result from political developments in the Middle East, weather patterns, and other economic fundamentals. As oil prices continue to break out of low price ranges achieved in 1998, it is possible that volatility will continue as well. Soft Commodities and Agriculturals. On June 30, 1999, the Partnership had a reasonable amount of exposure in the markets that comprise these sectors. Most of the exposure, however, was in the soft commodities. Supply and demand inequalities, severe weather disruption and market expectations affect price movements in these markets. Qualitative Disclosures Regarding Non-Trading Risk Exposure The following was the only non-trading risk exposure of the Partnership as of June 30, 1999: Foreign Currency Balances. The Partnership's foreign currency balances are in Japanese yen, British pounds, euros, Swiss Francs and Australian dollars. The Partnership controls the non-trading risk of these balances by regularly converting these balances back into dollars upon liquidation of the respective position. Qualitative Disclosures Regarding Means of Managing Risk Exposure The means by which the Partnership and the Trading Manager, severally, attempt to manage the risk of the Partnership's open positions are essentially the same in all market categories traded. Demeter attempts to manage the Partnership's market exposure by (i) diversifying the Partnership's assets among different market sectors and trading approaches, and (ii), monitoring the performance of the Trading Manager on a daily basis. In addition, the Trading Manager establishes diversification guidelines, often set in terms of the maximum margin to be committed to positions in any one market sector or market sensitive instrument. Demeter monitors and controls the risk of the Partnership's non- trading instrument, cash, which is the only Partnership investment directed by Demeter, rather than the Trading Manager. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The following supplements Legal Proceedings previously disclosed in the Partnership's 1998 Form 10-K: With respect to the plaintiffs' consolidated action in California, on July 1, 1999, the Superior Court of the State of California, ruling from the bench, denied the plaintiffs' motion to have their lawsuit certified as a class action, stating, among other things, that plaintiffs' lawsuit did not present common questions of fact. Item 6. Exhibits and Reports on Form 8-K (A) Exhibits - None. (B) Reports on Form 8-K. - None. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dean Witter Diversified Futures Fund II L.P. (Registrant) By: Demeter Management Corporation (General Partner) August 13, 1999 By: /s/ Lewis A. Raibley, III Lewis A. Raibley, III Director and Chief Financial Officer The General Partner which signed the above is the only party authorized to act for the Registrant. The Registrant has no principal executive officer, principal financial officer, controller, or principal accounting officer and has no Board of Directors.