Emerging markets: bonds

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From the course by University of Geneva

Understanding Financial Markets

2009 ratings

University of Geneva

Understanding Financial Markets

2009 ratings

Course 1 of 5 in the Specialization Investment Management

In this course, you will learn what the main financial markets and their characteristics are as well as how they are linked to the economy. Our very diversified team of experts will start by teaching you how the price of stocks and bonds are computed and why they move while you will become increasingly aware of the notion of risk and why it matters when measuring an investment's performance. The focus will then move to less popular markets such as gold, emerging markets, real estate, hedge funds and private markets. These will be analyzed with an emphasis on their particular risks and return opportunities as well as how they can help in building efficient portfolios. Finally, the policies of central banks and their impact on financial markets will be presented to you along with the link between the economy and the price of financial assets. All along these different steps, experts from UBS, our corporate partner, will show you how the concepts you just acquired are effectively applied in a leading global bank. This focus on practicality means you will not only understand what is going on in global financial markets but also start to figure out how you can use them to achieve financial goals, be it a client's or your own.

From the lesson

Other Financial Markets

What you will learn in this module1:25

Emerging markets: stocks10:39

Emerging markets: bonds7:16

Gold: the ultimate currency? - Part 17:19

Gold: the ultimate currency? - Part 27:20

Gold: the ultimate currency? - Part 37:34

Meet the Instructors

University of Geneva- Ines Chaieb
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Martin Hoesli
Professor of Real estate investments
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute
University of Geneva- Philip Valta
SFI Assistant Professor of Finance
Geneva Finance Research Institute
Dirk Effenberger
UBS Guest Lecturer, Head CIO Cross-Regional Investment Office
Chief Investment Office, UBS Wealth Management
Mark Haefele
UBS Guest Lecturer, Global Chief Investment Officer
Wealth Management and Wealth Management Americas
Brian Nick
UBS Guest Lecturer, Strategist
Chief Investment Office, UBS Wealth Management Americas
Mike Ryan
UBS Guest Lecturer, Chief Investment Strategist
Chief Investment Office, UBS Wealth Management Americas
Simon Smiles
UBS Guest Lecturer, Chief Investment Officer UHNW
Chief Investment Office, UBS Wealth Management
Themis Themistocleous
UBS Guest Lecturer, Head European Investment Office
Chief Investment Office, UBS Wealth Management
Thomas Wacker
UBS Guest Lecturer, Head CIO Credit
Chief Investment Office, UBS Wealth Management
Chris Wright
UBS Guest Lecturer, Cross-Asset Strategist
Chief Investment Office, UBS Wealth Management
University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute

[MUSIC]

Hello, this is me again, Ines and we continue talking about emerging markets.

But now, we're going to talk about bonds.

After this video,

you should be able to describe the relative size of emerging market bonds and

distinguish between local currency denominated and dollar denominated bonds.

Describe the returns and risks of emerging markets sovereign bonds and

how they compare to emerging market equity.

Compute a yield spread given the yields for two securities and

describe the factors that determine the sovereign yield spread.

If we look here at the relative contribution of the bonds,

so we distinguish between the government bonds and

these are issued either in local currency or

in dollars and corporate bonds.

And we see that the government bonds represent more about three quarters

of the total market cap of emerging market bonds.

What's interesting here also to see is that

a larger fraction is due to local currency bond.

So historically, in following that debt

crisis of many Latin American countries.

These countries were issuing bonds in heart currency.

In currency of highly stabled government such as Dollars,

the Pound, the Yen, the Swiss Franc and

this is actually the bonds that are attracted for investors,

but this creates a serious mismatch for the emerging market government.

And now, they embarked on developing their local currency bonds and

this local currency bond represents now about 53%

of the total capitalization of the emerging market bonds.

How about the return and risk characteristics of these sovereign bonds?

Now when I say, sovereign bonds, it means bonds issued by the sovereign.

Or equally, I could say, government bonds.

So you see here that emerging market bonds,

sovereign bonds have higher return compared, for example, to the treasury.

It's not shown in this table, but

these are higher returns, but also higher volatility.

And what's also interesting to see here is that if we compare to equity,

the emerging markets sovereign bonds have lower volatility

Another interesting thing we should look at is the yield spread and

it's defined as the difference between the yield on a sovereign bond,

let's say, issued by an emerging market such as Brazil in dollars.

For some maturity it,

this bond issued by the US Treasury for

the same maturity.

So the two bonds have the same maturity, the same denomination.

Both are in dollars, but one is issued by the Brazilian Government and

the other one is issued by US Treasury.

The US Treasury's safer.

So, the difference between the two yields measure the yield spread.

Let's take an example.

The Brazilian ten-year dollar-denominated bond has a yield of 7%.

The US Treasury with the same maturity ten years offer 2% yield.

So here, we have a yield spread of 7 minus 2, about 5% or 500 bases points.

So, let's try to understand what determines this yield spread.

So what are the risks when investing in sovereign bonds and specifically,

emerging Market Sovereign bonds.

So, the first is interest rate risk typically measured by duration.

There's also that country and credit risk.

It used to be quite high especially actually for

dollar denominated bonds.

And now that emerging markets manages to stabilize inflation,

to stabilize their government and political risk in general.

They are able to issue bonds with higher credit rating,

then we have currency risk.

The currency risk is not an issue for dollar-denominated bonds, but

is definitely an issue for local currency bonds.

And unlike for equity, currency risk is quite significant for bonds.

So your Swiss investor and you invest in the Brazilian

sovereign bond issued in Brazilian Real.

So, you care about returns with Franc.

So the Swiss Franc return this Brazilian sovereign

bond is the Brazilian return plus the change and

exchange rate, Franc versus Brazilian Real.

And a large part of the volatility in your return is going to be due to

the change in exchange rate of the real versus the Swiss Franc.

The other risk is liquidity risk.

Sovereign parts have higher transaction costs.

High [INAUDIBLE] spread and higher price impact compared

to bond issued by development market governments.

So what determines your spread is essentially country and credit risk and

liquidity risk and liquidity risk can be quite significant, especially during

crisis periods as the one we witnessed during the credit crash of 2008.

So to summarize after this video, you should be able to the relative

size of the bond market distinguish between local currency denominated and

dollar denominated bonds and to stand the risk and

return characteristics of the sovereign bonds.

The measure of the yield spread given the yield for two securities and

describe the factors that determine the yield spread.

[MUSIC]

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