10-Q 1 cs2.txt CORNERSTONE FUND 2 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, 2004 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. 0-13298 DEAN WITTER CORNERSTONE FUND II (Exact name of registrant as specified in its charter) New York 13-3212871 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Demeter Management Corporation 825 Third Avenue, 9th Floor New York, NY 10022 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 310-6444 (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 Indicate by check-mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X DEAN WITTER CORNERSTONE FUND II INDEX TO QUARTERLY REPORT ON FORM 10-Q June 30, 2004

PART I. FINANCIAL INFORMATION Item 1. Financial Statements

DEAN WITTER CORNERSTONE FUND II STATEMENTS OF OPERATIONS (Unaudited)

DEAN WITTER CORNERSTONE FUND II STATEMENTS OF OPERATIONS (Unaudited)

DEAN WITTER CORNERSTONE FUND II STATEMENTS OF CHANGES IN PARTNERS' CAPITAL For the Six Months Ended June 30, 2004 and 2003 (Unaudited)

DEAN WITTER CORNERSTONE FUND II STATEMENTS OF CASH FLOWS (Unaudited)

DEAN WITTER CORNERSTONE FUND II NOTES TO FINANCIAL STATEMENTS June 30, 2004 (Unaudited) The unaudited financial statements contained herein include, in the opinion of management, all adjustments necessary for a fair presentation of the results of operations and financial condition of Dean Witter Cornerstone Fund II (the "Partnership"). The financial statements and condensed notes herein should be read in conjunction with the Partnership's December 31, 2003 Annual Report on Form 10-K. 1. Organization Dean Witter Cornerstone Fund II is a New York limited partnership organized to engage in the speculative trading of futures contracts, options on futures contracts and forward contracts on foreign currencies and other commodity interests. The Partnership is one of the Dean Witter Cornerstone Funds, comprised of the Partnership, Dean Witter Cornerstone Fund III, and Dean Witter Cornerstone Fund IV. The Partnership's general partner is Demeter Management Corporation ("Demeter"). The non-clearing commodity broker is Morgan Stanley DW Inc. ("Morgan Stanley DW"). The clearing commodity brokers are Morgan Stanley & Co. Incorporated ("MS & Co.") and Morgan Stanley & Co. International Limited ("MSIL"). DEAN WITTER CORNERSTONE FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) Demeter, Morgan Stanley DW, MS & Co. and MSIL are wholly-owned subsidiaries of Morgan Stanley. The trading managers to the Partnership are Northfield Trading L.P. and John W. Henry & Company, Inc. (individually, a "Trading Manager", or collectively, the "Trading Managers"). 2. Related Party Transactions The Partnership's cash is on deposit with Morgan Stanley DW, MS & Co., and MSIL in futures, forwards and options trading accounts to meet margin requirements as needed. Morgan Stanley DW pays interest on these funds based on a rate equal to the average yield on current 13-week U.S. Treasury bills. The Partnership pays brokerage commissions to Morgan Stanley DW. 3. Financial Instruments The Partnership trades futures contracts, options on futures contracts, and forward contracts on foreign currencies 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. DEAN WITTER CORNERSTONE FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) The market value of contracts is based on closing prices quoted by the exchange, bank or clearing firm through which the contracts are traded. The Partnership's contracts are accounted for on a trade-date basis and marked to market on a daily basis. The Partnership accounts for its derivative investments in accordance with the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 defines a derivative as a financial instrument or other contract that has all three of the following characteristics: 1) One or more underlying notional amounts or payment provisions; 2) Requires no initial net investment or a smaller initial net investment than would be required relative to changes in market factors; 3) Terms require or permit net settlement. Generally, derivatives include futures, forward, swaps or options contracts, and other financial instruments with similar characteristics such as caps, floors, and collars. DEAN WITTER CORNERSTONE FUND II NOTES TO FINANCIAL STATEMENTS (CONTINUED) The net unrealized gains (losses) on open contracts, reported as a component of "Equity in futures interests trading accounts" on the statements of financial condition, and their longest contract maturities were as follows: Net Unrealized Gains (Losses) On Open Contracts Longest Maturities Exchange- Off-Exchange- Exchange- Off-Exchange- Date Traded Traded Total Traded Traded $ $ $ Jun. 30, 2004 (517,173) (491,441) (1,008,614) Dec. 2005 Sep. 2004 Dec. 31, 2003 748,037 550,423 1,298,460 Dec. 2004 Mar. 2004 The Partnership has 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. The Partnership also has credit risk because Morgan Stanley DW, MS & Co. and MSIL act as the futures commission merchants or the counterparties, with respect to most of the Partnership's assets. Exchange-traded futures, forward, and futures-styled options contracts are marked to market on a daily basis, with variations in value settled on a daily basis. Morgan Stanley DW, MS & Co., and MSIL, each as a futures commission merchant for the Partnership's exchange-traded futures, forward, and futures-styled DEAN WITTER CORNERSTONE FUND II NOTES TO FINANCIAL STATEMENTS (CONCLUDED) options 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, forward, and futures-styled options contracts, including an amount equal to the net unrealized gains (losses) on all open futures, forward and futures-styled options contracts, which funds, in the aggregate, totaled $17,729,335 and $21,675,501 at June 30, 2004 and December 31, 2003, respectively. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily exchange-required settlements of variations in value nor is there any requirement that an amount equal to the net unrealized gains (losses) on open forward contracts be segregated, however, MS & Co. and Morgan Stanley DW will make daily settlements of losses as needed. With respect to those off- exchange-traded forward currency contracts, the Partnership is at risk to the ability of MS & Co., the sole counterparty on all such contracts, to perform. The Partnership has a netting agreement with MS & Co. This agreement, which seeks to reduce both the Partnership's and MS & Co.'s exposure on off-exchange-traded forward currency contracts, should materially decrease the Partnership's credit risk in the event of MS & Co.'s bankruptcy or insolvency. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity. The Partnership deposits its assets with Morgan Stanley DW as non-clearing broker and MS & Co. and MSIL as clearing brokers in separate futures, forwards, and options trading accounts established for each Trading Manager, which assets are used as margin to engage in trading and may be used as margin solely for the Partnership's trading. The assets are held in either non-interest bearing bank accounts or in securities and instruments permitted by the CFTC for investment of customer segregated or secured funds. Since the Partnership's sole purpose is to trade in futures, forwards and options, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in futures, forwards, and options may, from time to time, be illiquid. Most U.S. futures exchanges limit fluctuations in prices during a single day by regulations referred to as "daily price fluctuations limits" or "daily limits". Trades may not be executed at prices beyond the daily limit. If the price for a particular futures or options contract has increased or decreased by an amount equal to the daily limit, positions in that futures or options contract can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. These market conditions could prevent the Partnership from promptly liquidating its futures or options contracts and result in restrictions on redemptions. There is no limitation on daily price moves in trading forward contracts on foreign currencies. 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 prevent the Partnership from promptly liquidating unfavorable positions in such markets, subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions. For the periods covered by this report, illiquidity has not materially affected the Partnership's assets. There are no known material trends, demands, commitments, events or uncertainties at the present time that will result in, or that are reasonably likely to result in, the Partnership's liquidity increasing or decreasing in any material way. Capital Resources. The Partnership does not have, nor expect to have, any capital assets. Redemptions of additional units of limited partnership interest ("Unit(s)") in the future will affect the amount of funds available for investment in futures, forwards, and options in subsequent periods. It is not possible to estimate the amount, and therefore the impact, of future redemptions of Units. There are no known material trends, favorable or unfavorable, that would affect, nor any expected material changes to, the Partnership's capital resource arrangements at the present time. Off-Balance Sheet Arrangements and Contractual Obligations. The Partnership does not have any off-balance sheet arrangements, nor does it have contractual obligations or commercial commitments to make future payments that would affect its liquidity or capital resources. Results of Operations General. The Partnership's results depend on the Trading Managers and the ability of each Trading Manager's trading programs to take advantage of price movements in the futures, forwards, and options markets. The following presents a summary of the Partnership's operations for the three and six month periods ended June 30, 2004 and 2003, and a general discussion of its trading activities during each period. It is important to note, however, that the Trading Managers trade in various markets at different times and that prior activity in a particular market does not mean that such market will be actively traded by the Trading Managers or will be profitable in the future. Consequently, the results of operations of the Partnership are difficult to discuss other than in the context of the Trading Managers' trading activities on behalf of the Partnership during the period in question. Past performance is no guarantee of future results. The Partnership's results of operations set forth in the financial statements on pages 2 through 11 of this report were prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of certain accounting policies that affect the amounts reported in these financial statements, including the following: The contracts the Partnership trades are accounted for on a trade-date basis and marked to market on a daily basis. The difference between their cost and market value is recorded on the Statements of Operations as "Net change in unrealized trading profit/loss" for open (unrealized) contracts, and recorded as "Realized trading profit/loss" when open positions are closed out, and the sum of these amounts constitutes the Partnership's trading results. The market value of a future contract is the settlement price on the exchange on which that futures contract is traded on a particular day. The value of foreign currency forward contracts is based on the spot rate as of the close of business, New York City time, on a given day. Interest income revenue, as well as management fees, incentive fees and brokerage commissions expenses of the Partnership are recorded on an accrual basis. Demeter believes that, based on the nature of the operations of the Partnership, no assumptions relating to the application of critical accounting policies other than those presently used could reasonably affect reported amounts. For the Quarter and Six Months Ended June 30, 2004 The Partnership recorded losses net of interest income totaling $3,578,242 and expenses totaling $480,091, resulting in a net loss of $4,058,333 for the quarter ended June 30, 2004. The Partnership's net asset value per Unit decreased from $4,977.27 at March 31, 2004 to $4,033.75 at June 30, 2004. The most significant trading losses of approximately 11.1% were incurred in the currency markets from positions in the Japanese yen, Singapore dollar, and European currencies versus the U.S. dollar. Speculation for increases in U.S. interest rates and the release of mixed U.S. economic data caused erratic trading patterns in the value of the U.S. dollar. Better than anticipated improvements in Japanese economic data encouraged speculation for an increase in Japanese interest rates and caused choppy trading in the yen also. Finally, positions in the South African rand versus the U.S. dollar also contributed losses as long positions were hurt during April as the dollar moved higher in response to rising interest rate outlooks. During May, short rand positions suffered losses as the rand's value benefited from strengthening gold prices. Losses of approximately 4.0% were recorded in the global interest rates markets, primarily during June, from positions in Japanese interest rate futures. Long positions experienced losses as prices first decreased amid anticipation that the Bank of Japan would raise interest rates during June. Later in the month, additional losses were recorded from newly established short positions as prices rose following the Japanese Central Bank's decision to leave their interest rate policy unchanged. Long European and Australian interest rate futures positions also incurred losses as fixed income prices tumbled following the release of stronger than expected U.S. jobs data during early April. Further Partnership losses of approximately 3.9% were experienced in the global stock indices. During May, long positions in Japanese and European equity index futures resulted in losses as equity prices declined in response to geopolitical concerns and expanding energy prices. Newly established short positions in these markets, as well as in U.S. stock indices, experienced additional losses as prices rebounded later in May. During June, losses from short positions in Japanese stock indices were incurred as prices strengthened on renewed investor sentiment regarding the Japanese economic recovery. Short positions in European stock indices followed as prices benefited from the release of positive economic data. In the metals markets, losses of approximately 3.2% were experienced from positions in both precious and base metals. During April, prices weakened from a stronger U.S. dollar and a decline in Asian demand. During May, short futures positions in copper, nickel and gold accounted for the majority of sector losses. The Partnership recorded losses net of interest income totaling $3,043,753 and expenses totaling $1,018,727, resulting in a net loss of $4,062,480 for the six months ended June 30, 2004. The Partnership's net asset value per Unit decreased from $4,981.39 at December 31, 2003 to $4,033.75 at June 30, 2004. The most significant trading losses of approximately 19.8% were incurred in the currency markets from short positions in the Japanese yen, South African rand, and euro versus the U. S. dollar. Short Japanese yen positions experienced losses during March as the yen reversed higher due to speculation that the Bank of Japan was relaxing its efforts to weaken the yen. Short euro positions suffered losses also during March as expectations for an interest rate reduction by the European Central Bank dissipated. During February, short positions in the South African rand produced losses as the value of the rand reversed upwards following the release of positive South African economic data. During April, May, and June, losses stemmed from positions in the Japanese yen, Singapore dollar, and European currencies versus the U.S. dollar. Speculation for increases in U.S. interest rates and the release of mixed U.S. economic data caused erratic trading patterns in the value of the dollar. Additional losses of approximately 3.6% stemmed from the global stock index markets. During May, long positions in Japanese and European equity index futures resulted in losses as equity prices declined in response to geopolitical concerns and expanding energy prices. Newly established short positions in these markets, as well as in U.S. stock indices, experienced additional losses as prices rebounded later in May. During June, losses from short positions in Japanese stock indices were incurred as prices strengthened on renewed investor sentiment regarding the Japanese economic recovery. Short positions in European stock indices followed as prices benefited from the release of positive economic data. Additional losses of approximately 0.9% were incurred from the global interest rate markets, primarily during June, from positions in Japanese interest rate futures. Long positions experienced losses as prices first decreased amid anticipation that the Bank of Japan would raise interest rates. Later in the month, additional losses were recorded from newly established short positions as prices rose following the Japanese Central Bank's decision to leave their interest rate policy unchanged. Losses in the metals markets of approximately 0.8% resulted from positions in both precious and base metals. During April, industrial metals prices profited from a weaker U.S. dollar and strong Asian demand. Gold prices also increased as investor interest was reignited by a weaker U.S. dollar and fears of potential terrorist attacks. During May, short futures positions in copper, nickel, and gold accounted for the majority of sector losses. A portion of the Partnership's overall losses for the first six months of the year was offset by gains of approximately 5.5% recorded in the energy markets, primarily during February, April, and May, from long futures positions in crude oil and its related products as low market supply, falling inventory levels, production cut announcements from OPEC, and fears of potential terrorist activity in Saudi Arabia pushed prices higher. In the agricultural markets, gains of approximately 1.4% were generated from long futures positions in corn, soybeans, and soybean related products. Growing U.S. exports and heightened demand from Asia pushed prices for these commodities higher during the first quarter. During April, short futures positions in cotton gained as prices trended lower due to news of a decrease in demand from China and a landmark decision by the World Trade Organization that denounced U.S. and European cotton subsidies. Long futures positions in live cattle supplemented sector gains as inflationary concerns lifted agricultural commodity prices higher. For the Quarter and Six Months Ended June 30, 2003 The Partnership recorded losses net of interest income totaling $228,825 and expenses totaling $501,675, resulting in a net loss of $730,500 for the quarter ended June 30, 2003. The Partnership's net asset value per Unit decreased from $5,346.51 at March 31, 2003 to $5,187.29 at June 30, 2003. The most significant trading losses of approximately 2.4% were recorded in the metals markets, primarily during June, from long positions in gold futures as prices declined in response to the rise of the U.S. dollar. Elsewhere in the metals markets, short positions in copper, nickel, and aluminum futures generated losses during May as prices reversed higher, buoyed by a rebound in U.S. equity prices and hopes for increased industrial demand. Losses of approximately 1.1% were recorded in the agricultural markets primarily during May from long positions in coffee futures as prices reversed lower on technically-based factors. Elsewhere in the agricultural markets, losses were experienced during June from short positions in cotton futures as increased exports and weather related supply concerns forced prices higher. In the energy markets, losses of approximately 0.9% were recorded primarily during May from short futures positions in crude oil as prices moved higher amid supply concerns and renewed fears concerning security at Middle Eastern refining facilities. A portion of the Partnership's overall losses for the quarter was offset by gains of approximately 1.4% recorded in the global stock index markets during April and May from long positions in U.S. stock index futures as prices increased due to investors focusing on positive comments and profits by technology companies instead of weak economic data and geopolitical concerns. Additional gains in the global stock index futures markets were recorded during June from long positions in Japanese stock index futures as prices rallied amid increased foreign demand for Japanese equities. Smaller gains of approximately 0.4% were experienced in the global interest rate markets from long positions in U.S. interest rate futures primarily during May as prices trended higher amid speculation of an interest rate cut by the U.S. Federal Reserve and lingering doubts concerning a global economic recovery. The Partnership recorded revenues including interest income totaling $2,515,202 and expenses totaling $1,427,419, resulting in net income of $1,087,783 for the six months ended June 30, 2003. The Partnership's net asset value per Unit increased from $4,963.25 at December 31, 2002 to $5,187.29 at June 30, 2003. The most significant trading gains of approximately 3.7% were recorded in the energy markets primarily during January and February from long positions in natural gas futures as prices trended higher in response to prolonged frigid temperatures in the northeastern and midwestern United States. Additional gains of approximately 3.0% were established in the global interest rate markets during January, February, and May from long positions in U.S. and European interest rate futures as prices trended higher amid continued uncertainty in the global equity markets and investor demand for fixed income investments. In the currency markets, gains of approximately 1.3% were experienced primarily during January, February, and April from long positions in the euro and Australian dollar versus the U.S. dollar as the value of these currencies strengthened versus the U.S. dollar amid uncertainty regarding the Bush Administration's economic policy, renewed fears of potential terrorist attacks against American interests, and investor preference for non-U.S. dollar denominated assets. Additional gains of approximately 1.1% were recorded in the global stock index markets from long positions in European stock index futures as prices strengthened amid the release of positive economic data and expectations for a U.S. interest rate cut. A portion of the Partnership's overall gains was offset by losses of approximately 2.3% recorded in the metals markets from positions in gold and silver futures as precious metals prices experienced short-term volatility throughout a majority of the first half of the year. Smaller losses of approximately 0.9% were experienced in the agricultural futures markets during May from long positions in coffee futures as prices reversed lower on technically-based factors, and from short positions in wheat futures as prices moved higher amid news that continued hot-dry weather in the midwest was hurting crops. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction The Partnership is a commodity pool engaged primarily in the speculative trading of futures, forwards, and options. The market-sensitive instruments held by the Partnership are acquired for speculative trading purposes only and, as a result, all or substantially all of the Partnership's assets are at risk of trading loss. Unlike an operating company, the risk of market- sensitive instruments is inherent to the primary business activity of the Partnership. The futures, forwards, and options traded by the Partnership involve varying degrees of related market risk. Market risk is often dependent upon changes in the level or volatility of interest rates, exchange rates, and prices of financial instruments and commodities, factors that result in frequent changes in the fair value of the Partnership's open positions, and consequently in its earnings, whether realized or unrealized, and cash flow. Gains and losses on open positions of exchange- traded futures, forward, and options are settled daily through variation margin. Gains/losses on off-exchange-traded forward currency contracts are settled at the termination of the contract or more frequently, as agreed upon with each counterparty. The Partnership's total market risk may increase or decrease as it is influenced by a wide variety of factors, including, but not limited to, the diversification among the Partnership's open positions, the volatility present within the markets, and the liquidity of the markets. The Partnership's past performance is no guarantee of its future results. Any attempt to numerically quantify the Partnership's market risk is limited by the uncertainty of its speculative trading. The Partnership's speculative trading may cause future losses and volatility (i.e., "risk of ruin") that far exceed the Partnership's experience to date or any reasonable expectations based upon historical changes in market value. Limited partners will not be liable for losses exceeding the current net asset value of their investment. 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. Any loss in the market value of the Partnership's open positions is directly reflected in the Partnership's earnings and cash flow. The Partnership's risk exposure in the market sectors traded by the Trading Managers is estimated below in terms of Value at Risk ("VaR"). The Partnership estimates VaR using a model based upon historical simulation (with a confidence level of 99%) which involves constructing a distribution of hypothetical daily changes in the value of a trading portfolio. The VaR model takes into account linear exposures to risk including equity and commodity prices, interest rates, foreign exchange rates, and correlation among these variables. The hypothetical changes in portfolio value are based on daily percentage changes observed in key market indices or other market factors ("market risk factors") to which the portfolio is sensitive. The one-day 99% confidence level of the Partnership's VaR corresponds to the negative change in portfolio value that, based on observed market risk factors, would have been exceeded once in 100 trading days, or one day in 100. VaR typically does not represent the worst case outcome. Demeter uses approximately four years of daily market data (1,000 observations) and revalues its portfolio (using delta-gamma approximations) for each of the historical market moves that occurred over this time period. This generates a probability distribution of daily "simulated profit and loss" outcomes. The VaR is the appropriate percentile of this distribution. For example, the 99% one-day VaR would represent the 10th worst outcome from Demeter's simulated profit and loss series. The Partnership's VaR computations are based on the risk representation of the underlying benchmark for each instrument or contract and do not distinguish between exchange and non-exchange dealer-based instruments. They are also not based on exchange and/or dealer-based maintenance margin requirements. VaR models, including the Partnership's, are continually evolving as trading portfolios become more diverse and modeling techniques and systems capabilities improve. Please note that the VaR model is used to numerically quantify market risk for historic reporting purposes only and is not utilized by either Demeter or the Trading Managers in their daily risk management activities. Please further note that VaR as described above may not be comparable to similarly titled measures used by other entities. 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 primary market risk category at June 30, 2004 and 2003. At June 30, 2004 and 2003, the Partnership's total capitalization was approximately $17 million and $24 million, respectively. Primary Market June 30, 2004 June 30, 2003 Risk Category Value at Risk Value at Risk Currency (1.80)% (1.40)% Interest Rate (0.90) (0.89) Equity (0.73) (0.64) Commodity (2.14) (1.65) Aggregate Value at Risk (3.01)% (2.43)% The VaR for a market category represents the one-day downside risk for the aggregate exposures associated with this market category. The Aggregate Value at Risk listed above represents the VaR of the Partnership's open positions across all the market categories, and is less than the sum of the VaRs for all such market categories due to the diversification benefit across asset classes. Because the business of the Partnership is the speculative trading of futures, forwards, and options, the composition of its trading portfolio can change significantly over any given time period, or even within a single trading day, which could positively or negatively materially impact market risk as measured by VaR. The table below supplements the quarter-end VaR set forth above by presenting the Partnership's high, low, and average VaR, as a percentage of total net assets for the four quarter-end reporting periods from July 1, 2003 through June 30, 2004. Primary Market Risk Category High Low Average Currency (2.50)% (1.53)% (2.07)% Interest Rate (0.96) (0.83) (0.91) Equity (0.87) (0.40) (0.70) Commodity (2.14) (1.57) (1.87) Aggregate Value at Risk (3.32)% (2.37)% (2.97)% 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 requirements. Margin requirements generally range between 2% and 15% of contract face value. Additionally, the use of leverage causes the face value of the market sector instruments held by the Partnership to typically be many times the total capitalization of the Partnership. The value of the Partnership's open positions thus creates a "risk of ruin" not typically found in other investments. The relative size of the positions held may cause the Partnership to incur losses greatly in excess of VaR within a short period of time, given the effects of the leverage employed and market volatility. The VaR tables above, as well as the past performance of the Partnership, give no indication of such "risk of ruin". In addition, VaR risk measures should be viewed in light of the methodology's limitations, which include the following: ? past changes in market risk factors will not always result in accurate predictions of the distributions and correlations of future market movements; ? changes in portfolio value caused by market movements may differ from those of the VaR model; ? VaR results reflect past market fluctuations applied to current 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 VaR tables provided 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, 2004 and 2003, and for the four quarter-end reporting periods from July 1, 2003 through June 30, 2004. VaR is not necessarily representative of the Partnership's historic risk, nor should it be used to predict the Partnership's future financial performance or its ability to manage or monitor risk. There can be no assurance that the Partnership's actual losses on a particular day will not exceed the VaR amounts indicated above or that such losses will not occur more than once in 100 trading days. Non-Trading Risk The Partnership has non-trading market risk on its foreign cash balances not needed for margin. These balances and any market risk they may represent are immaterial. The Partnership also maintains a substantial portion (approximately 101% as of June 30, 2004) of its available assets in cash at Morgan Stanley DW. A decline in short-term interest rates would result in a decline in the Partnership's cash management income. This cash flow risk is not considered to be material. Materiality, as used throughout this section, is based on an assessment of reasonably possible market movements and any associated potential losses, taking into account the leverage, optionality and multiplier features of the Partnership's market- sensitive instruments, in relation to the Partnership's net assets. Qualitative Disclosures Regarding Primary Trading Risk Exposures The following qualitative disclosures regarding the Partnership's market risk exposures - except for (A) those disclosures that are statements of historical fact and (B) 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 Managers 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 at June 30, 2004, by market sector. It may be anticipated, however, that these market exposures will vary materially over time. Currency. The primary market exposure of the Partnership at June 30, 2004 was to the currency sector. The Partnership's currency exposure is to exchange rate fluctuations, primarily fluctuations which 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's primary exposure at June 30, 2004 was to outright U.S. dollar positions. Outright positions consist of the U.S. dollar vs. other currencies. These other currencies include major and minor currencies. Demeter does not anticipate that the risk profile of the Partnership's currency sector will change significantly in the future. Interest Rate. The second largest market exposure of the Partnership at June 30, 2004 was to the global interest rate sector. Exposure was primarily spread across the Japanese, U.S. and European 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 U.S. and the other G-7 countries. The G-7 countries consist of France, the U.S., Britain, Germany, Japan, Italy, and Canada. However, the Partnership also takes futures positions in the government debt of smaller countries - e.g., Australia. Demeter anticipates that the G-7 countries and Australian interest rates will remain the primary interest rate exposures of the Partnership for the foreseeable future. The speculative futures positions held by the Partnership may range from short to long-term instruments. Consequently, changes in short, medium or long-term interest rates may have an effect on the Partnership. Equity. The third largest market exposure of the Partnership at June 30, 2004 was to equity price risk in the G-7 countries. The stock index futures traded by the Partnership are by law limited to futures on broadly-based indices. At June 30, 2004, the Partnership's primary exposures were to the DAX (Germany), Euro Stoxx 50 (Europe), and NASDAQ (U.S.) stock indices. The Partnership is primarily exposed to the risk of adverse price trends or static markets in the U.S. and European stock indices. Static markets would not cause major market changes, but would make it difficult for the Partnership to avoid trendless price movements, resulting in numerous small losses. Commodity. Energy. The Partnership's energy exposure at June 30, 2004 was primarily to futures contracts in crude oil and its related products, and natural gas. Price movements in these markets result from geopolitical developments, particularly in the Middle East, as well as weather patterns and other economic fundamentals. Significant profits and losses, which have been experienced in the past, are expected to continue to be experienced in the future. Natural gas has exhibited volatility in price resulting from weather patterns and supply and demand factors and will likely continue in this choppy pattern. Metals. The Partnership's metals exposure at June 30, 2004 was to fluctuations in the price of precious metals, such as gold and silver, and base metals, such as copper, nickel, aluminum, and zinc. Economic forces, supply and demand inequalities, geopolitical factors and market expectations influence price movements in these markets. The Trading Managers, from time to time, take positions when market opportunities develop, and Demeter anticipates that the Partnership will continue to do so. Soft Commodities and Agriculturals. At June 30, 2004, the Partnership had exposure to the markets that comprise these sectors. Most of the exposure was to the cotton, coffee, sugar, and cocoa markets. Supply and demand inequalities, severe weather disruptions 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 at June 30, 2004: Foreign Currency Balances. The Partnership's primary foreign currency balances at June 30, 2004 were in Hong Kong dollars, Japanese yen, euros, and British pounds. The Partnership controls the non-trading risk of foreign currency balances by regularly converting them back into U.S. dollars upon liquidation of their respective positions. Qualitative Disclosures Regarding Means of Managing Risk Exposure The Partnership and the Trading Managers, separately, attempt to manage the risk of the Partnership's open positions in essentially the same manner in all market categories traded. Demeter attempts to manage market exposure by diversifying the Partnership's assets among different Trading Managers, each of whose strategies focus on different market sectors and trading approaches, and by monitoring the performance of the Trading Managers daily. In addition, the Trading Managers establish 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. Cash is the only Partnership investment directed by Demeter, rather than the Trading Managers. Item 4. CONTROLS AND PROCEDURES (a) As of the end of the period covered by this quarterly report, the President and Chief Financial Officer of Demeter, the general partner of the Partnership, have evaluated the effectiveness of the Partnership's disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) of the Exchange Act), and have judged such controls and procedures to be effective. (b) There have been no significant changes during the period covered by this quarterly report in the Partnership's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. PART II. OTHER INFORMATION Item 5. OTHER INFORMATION Management. Effective June 21, 2004, the following changes have been made to the Board of Directors and Officers of Demeter: Mr. Jeffrey D. Hahn resigned the position of Chief Financial Officer and Director of Demeter. Mr. Todd Taylor, age 41, is a Director of Demeter. Mr. Taylor began his career with Morgan Stanley in June 1987 as a Financial Advisor in the Dallas office. In 1995, he joined the Management Training Program in New York and was appointed Branch Manager in St. Louis in 1997. Three years later, in 2000, Mr. Taylor was appointed to a newly created position, Director of Individual Investor Group ("IIG") Learning and Development, before becoming the Director of IIG Strategy in 2002. Most recently, Mr. Taylor has taken on a new role as the High Net Worth Segment Director. Currently a member of the firm's E-Learning Council, Mr. Taylor is also a current member of the Securities Industry/Regulatory Council on Continuing Education. Mr. Taylor graduated from Texas Tech University with a B.B.A. in Finance. Mr. William D. Seugling, age 34, will become a Director of Demeter once he has registered with the National Futures Association ("NFA") as a principal, which registration is currently pending. Mr. Seugling is an Executive Director at Morgan Stanley and currently serves as Director of Client Solutions for US Private Wealth Management. Mr. Seugling joined Morgan Stanley in June 1993 as an Associate in Equity Structured Products having previously worked in research and consulting for Greenwich Associates from October 1991 to June 1993. Since 1994, he has focused broadly on analysis and solutions for wealthy individuals and families culminating in his current role within the division. He was named Vice President in 1996 and an Executive Director in 1999. Mr. Seugling graduated cum laude from Bucknell University with a B.S. in Management and a concentration in Chemistry. Mr. Kevin Perry, age 35, is the Chief Financial Officer of Demeter. His registration with the NFA as a principal is currently pending. He currently serves as an Executive Director and Controller of Client Solutions at Morgan Stanley. Mr. Perry joined Morgan Stanley in October 2000 and is also Chief Financial Officer of Morgan Stanley Trust National Association, Van Kampen Funds Inc. and Morgan Stanley Distribution, Inc. Prior to joining Morgan Stanley, Mr. Perry worked as an auditor and consultant in the financial services practice of Ernst & Young from October 1991 to October 2000. Mr. Perry received a B.S. degree in Accounting from the University of Notre Dame in 1991 and is a Certified Public Accountant. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits 3.01 Limited Partnership Agreement of the Partnership, dated December 7, 1983, as amended as of May 11, 1984, is incorporated by reference to Exhibit 3.01 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984 (File No. 0-13298). 10.01 Management Agreement among the Partnership, Demeter and John W. Henry & Company, Inc. dated November 15, 1983, is incorporated by reference to Exhibit 10.03 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984 (File No. 0-13298). 10.02 Dean Witter Cornerstone Funds Exchange Agreement, dated as of May 31, 1984, is incorporated by reference to Exhibit 10.04 of the Partnership's Annual Report on Form 10-K for the fiscal year ended September 30, 1984 (File No. 0- 13298). 10.03 Management Agreement among the Partnership, Demeter and Northfield Trading L.P., dated as of April 16, 1997, is incorporated by reference to Exhibit 10.03 of the Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 (File No. 0-13298). 10.04 Amended and Restated Customer Agreement between the Partnership and Morgan Stanley DW Inc., dated as of June 22, 2000, is incorporated by reference to Exhibit 10.01 of the Partnership's Form 8-K (File No. 0-13298) filed with the Securities and Exchange Commission on November 13, 2001. 10.05 Commodity Futures Customer Agreement between Morgan Stanley & Co. Incorporated and the Partnership, and acknowledged and agreed to by Morgan Stanley DW Inc., dated as of May 1, 2000, is incorporated by reference to Exhibit 10.02 of the Partnership's Form 8-K (File No. 0- 13298) filed with the Securities and Exchange Commission on November 13, 2001. 10.06 Customer Agreement between the Partnership and Morgan Stanley & Co. International Limited, dated as of May 1, 2000, is incorporated by reference to Exhibit 10.04 of the Partnership's Form 8-K (File No. 0-13298) filed with the Securities and Exchange Commission on November 13, 2001. 10.07 Foreign Exchange and Options Master Agreement between Morgan Stanley & Co. Incorporated and the Partnership, dated as of April 30, 2000, is incorporated by reference to Exhibit 10.05 of the Partnership's Form 8-K (File No. 0-13298) filed with the Securities and Exchange Commission on November 13, 2001. 10.08 Amendment to Management Agreement between the Partnership and John W. Henry & Company, Inc., dated as of November 30, 2000, is incorporated by reference to Exhibit 10.1 of the Partnership's Form 8-K (File No. 0-13298) filed with the Securities and Exchange Commission on January 3, 2001. 10.09 Amendment to Management Agreement between the Partnership and Northfield Trading L.P., dated as of November 30, 2000, is incorporated by reference to Exhibit 10.2 of the Partnership's Form 8-K (File No. 0-13298) filed with the Securities and Exchange Commission on January 3, 2001. 10.10 Securities Account Control Agreement among the Partnership, Morgan Stanley & Co. Incorporated, and Morgan Stanley DW Inc., dated as of May 1, 2000, is incorporated by reference to Exhibit 10.03 of the Partnership's Form 8- K (File No. 0-13298) filed with the Securities and Exchange Commission on November 13, 2001. 31.01 Certification of President of Demeter Management Corporation, the general partner of the Partnership, pursuant to rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02 Certification of Chief Financial Officer of Demeter Management Corporation, the general partner of the Partnership, pursuant to rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.01 Certification of President of Demeter Management Corporation, the general partner of the Partnership, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.02 Certification of Chief Financial Officer of Demeter Management Corporation, the general partner of the Partnership, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (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 Cornerstone Fund II (Registrant) By: Demeter Management Corporation (General Partner) August 16, 2004 By: /s/Kevin Perry Kevin Perry 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.

WITTER DEAN CORNERSTONE FUND II 10-Q