Financial Businesses

Market risk is incurred primarily through UBS’s trading activities, which are centered in the Investment Bank but also arise, to a much lesser extent, in the wealth management businesses. Our treasury department also assumes market risk as a result of its balance sheet and capital management responsibilities.

The first quarter started actively as the US dollar rallied against other currencies, equity markets rose and credit spreads continued to tighten. The buoyant markets supported a high level of mergers and acquisitions and new equity issuance. Oil prices increased in the period, driven by continued strong demand and concerns about inventory levels. The US Federal Reserve raised its funding rate target twice, but although both increases were widely expected, the hawkish comments on inflation that accompanied the second pushed up long-term rates and led to a steepening of the US dollar yield curve.

March saw disappointing returns on investment grade credits, with credit spreads finally widening from the seven-year lows reached during the quarter. In the foreign exchange markets, the US dollar gave up some of its earlier gains but still ended the quarter higher than at the end of 2004.

Market risk for the Investment Bank, as measured by the average 10-day 99% VaR, was CHF 371 million in first quarter 2005, slightly up from CHF 358 million in the previous quarter. We took advantage of the positive, active markets at the beginning of the quarter, with 10-day VaR peaking at CHF 517 million in early February, as can be seen in the backtesting chart above. Interest rate VaR, which reached its maximum of CHF 526 million at that point, was the main contributor, with exposures to the US markets being a significant driver. We reduced risk in anticipation of more negative sentiment towards the end of February, and 10-day VaR remained in a narrow range of CHF 300 million to CHF 350 million until late March. Renewed proprietary positions at the end of the quarter led to an increase in equities VaR, which had been fairly flat up to that point. Investment Bank VaR ended the quarter at CHF 392 million, compared to CHF 332 million at the end of the previous quarter.

Backtesting compares actual revenues arising from closing positions (i.e. excluding intra-day revenues, fees and commissions) with the 1-day VaR calculated on these positions, and is used to monitor the quality of the VaR model. The above graph shows these daily backtesting revenues and the corresponding 1-day VaR over the last 12 months. The 10-day VaR, which is the basis of the limits and exposures in the tables above, is also shown in this graph for information. Revenue volatility over the period was within the range predicted by the VaR model.

We also routinely assess and actively manage and control tail risks against a standard set of forward-looking scenarios supplemented by specific scenarios targeting individual sectors or reflecting current concerns, such as widening credit spreads or increased energy market volatility. Stress events modeled in our standard scenarios include crises in equity, corporate bond and emerging markets, and severe movements in currency, interest rate and energy markets. These scenarios are reviewed regularly and fine-tuned as necessary. Stress loss exposure ended the quarter higher than last quarter but the average was lower.

VaR and stress measures control our overall portfolio exposure but we also apply concentration controls on exposure to individual market risk variables, such as individual equity markets, currency, interest and foreign exchange rates, and single name issuers. The diversification of risks and avoidance of undue concentrations remain key pillars of our risk control process.