[MUSIC] Hi, I'm Thomas Wacker. I'm leading the Credit Research Department at the Chief Investment Office at UBS. In this session we're going to talk about investing in bonds. Global debt markets are actually about three times as large as the global stock market. That gives investors plenty of choice. The largest part of the debt market is in the form of bonds issued by governments and companies. There are various kinds of bond structures and bond types and there is virtually no year without an innovation in this market. The vast majority of bonds, however, has a fairly simple structure. It is a fixed term until you get the principal back, and it has a fixed interest payment, which we call a coupon, that you receive periodically. Bonds are usually issued and redeemed at 100% of their face value. In this case, the yield is the same as the coupon. But the fair yield for a bond can change during its life, and so does its price. The yield should basically compensate you for two things. A loss of purchasing power, as you lend your money out for quite a while, and the risk that you don't get it back. The expected loss of purchasing power of money, that's a key driver of what we call risk-free interest rates. Usually, we look at a reference issue, for what is called the risk-free rate. So like use treasuries for the dollar market. Or German bonds for the Euros. The key risk, that a bond investor needs to consider, Is that the issuer, whether a company or a government, will be unable or unwilling to pay its debt. The most common reference point for this risk are credit ratings. As they are provided by agencies, like Standard and Poor's, Moody's, or Fitch. Of course, unexpected developments can always turn what we thought was a good credit, into a bad one. But at least historical evidence suggests that issuers with high credit ratings have defaulted on their debt in much less cases than lower rated ones. The difficult part now is judging the appropriate additional reward. That an investor should demand for investing into a higher risk issuer. This compensation varies and it is often driven by similar factors that also move the stock market. A positive outlook for the economy usually results in lower bond risk premiums. Other drivers can have opposite effects on stocks and bonds. For example M and A transactions or share re-purchases. They're often good for the stock, but they're bad for the bonds, so if we put pieces together again, the risk-free interest rate plus the risk premium, that's the yield of a Bond. Now let's get back to what is the worst case for you as a bond holder. And it's a default by the issuer. It will then stop paying interest and it either tries to negotiate some partial depth forgiveness with its bond holders or it goes into liquidation. For governments, liquidation is clearly no option. So, they will always negotiate with bond holders. Which can go on for several years, like examples of Argentina which defaulted in 2004 and it still has pending lawsuits with its bond owners. On average, investors only recover about 30% of the nominal value if a company defaults and they may need to wait years to receive payments in case of liquidation. For Lehman brothers which was the big headline default of the financial crisis 2008. Liquidation is still on going today. But investing in lower quality credit, you need to be very careful not only one selecting in the issue but even more when finding the right instrument. Companies offering issue different types of bonds, and in some cases, reading the bond prospectus is really the only way to find out about instrument-specific risks and special features. Trading bonds is also quite different from trading stocks. Bonds are often not traded on exchanges, but between broker dealers. Which makes it harder for a private investor to observe a price level at which a bond can effectively be bought or sold. Many institutional investors buy bonds at the time when they're issued, and they keep them until the final maturity date. So there can be almost no secondary market transactions in some of the bonds, which obviously makes it very difficult to liquidate a position ahead of its redemption. So as a consequence, if you are holding a lower quality bond it is even more risky if this bond is also a liquid. Bond markets may not always be perfectly efficient but my number one investment advice for you is to be most suspicious when a bounty of looks excessively attractive. There's almost always a good reason for this. You can earn an extra yield, if you pick the right bonds but you are clearly not paid for being a hero in bond markets. [MUSIC]