Education Notes 2007

Besides publishing reports on equities, bonds and other investments, UBS Wealth Management Research also provides analysis and background information on specific issues of interest to investors in the "Education Notes" research publication. In these reports we share our financial knowledge with clients who would like to expand their understanding of topics that could influence their investment decisions.

UBS client advisors are happy to provide you with more information and other research publications.

Besides publishing reports on equities, bonds and other investments, UBS Wealth Management Research also provides analysis and background information on specific issues of interest to investors in the "Education Notes" research publication. In these reports we share our financial knowledge with clients who would like to expand their understanding of topics that could influence their investment decisions.

UBS client advisors are happy to provide you with more information and other research publications.

Education Notes 2007

Behavioral Finance 7: Mental Accounting

(21 December 2007 / UBS Wealth Management Research)

This Education Note, the final in our series on Behavioral Finance, examines how we manage our spending and investments by unconsciously applying intuitive accounting techniques. The primary benefit of Mental Accounting is that it manages "time and thinking costs" in an economical way.
Mental budgets help individuals deal with self-control problems. The drawback is a potential misallocation of funds. We may re-frain from good investments, and make poor ones instead.

Understanding Bonds, Part 10: Subordinated Debt

(14 December 2007 / UBS Wealth Management Research)

Banks issue substantial amounts of subordinated bonds. A bond's credit risk increases the more its structure resembles equity. Highly subordinated bonds gain or lose more than senior bonds do when an issuer's credit quality improves or deteriorates.
Hybrid bonds have both equity and debt components. From a risk perspective, hybrid bonds with no stated maturity date and with coupon deferral provisions closely resemble common stock.
Investors should pay attention to the performance implications of Source: UBS WMR coupon formulas and various options, which are common and sometimes complex elements of subordinated bonds.

International Diversification – A US dollar View

(13 December 2007 / UBS Wealth Management Research)

US Companies with international operations do provide some in-direct exposure to the global economy. However, the resulting exposure is not enough to eliminate the need to hold foreign in-vestments directly.

Socially Responsible Investing

(10 December 2007 / UBS Wealth Management Research)

Ecological and social factors play an important role in long-term business success today, a trend we expect only to increase in the future.
The main SRI strategies, often used in combination, include best-in-class, thematic investments, engagement, negative screening practices and
community-oriented investments.

Behavioral Finance 6: Heuristics and Biases

( 07 December 2007 / UBS Wealth Management Research)

The more a scenario is representative of what we have in mind, the higher we estimate its probability.
We tend to expect that bad luck is self-correcting over time and expect probabilities to hold in small samples.
The availability heuristic reflects the likelihood we assign to cer-tain events; the chances of highly unlikely events that capture a lot of attention are usually overestimated.
Anchoring and adjustment describe the problem of insufficiently adjusting estimates to new information. Even unrelated values are used as an anchor for an estimate, leading to errors.
In ex-post evaluation, successful decisions are usually attributed to personal abilities; whereas failures are blamed on external factors.

Understanding American Depositary Re-ceipts (ADR)

( 28 November 2007 / UBS Wealth Management Research)

The interconnectivity of global markets over the past 10 years has increased the correlation between US and global equity market re-turns, though diversification benefits still remain. By including for-eign stocks in a well-diversified portfolio investors can both reduce portfolio volatility and increase risk-adjusted portfolio returns.

Understanding Bonds Part 9: Convertible Bonds

( 27 November 2007 / UBS Wealth Management Research)

Convertible bonds can broadly be seen as a low-coupon bond with a long equity call option.
These securities react to developments in both the bond and the equity markets, usually responding to the better performing, more dominant of the two asset classes.

Behavioral Finance, Part 5: Speculative Investments

( 23 November 2007 / UBS Wealth Management Research)

When confronted with losses, many people tend to become more risk-seeking rather than more risk-averse.
While investors generally try to avoid losses, some level of highly speculative investments is common.
Resulting portfolios are considered in different mental accounts with different attitudes towards risk.

Investing in Emerging Markets Part 2: EM Bonds

( 20 November 2007 / UBS Wealth Management Research)

Emerging Market (EM) sovereign and corporate bonds still dif-fer from bonds of more developed markets Historically, EM bonds have been more volatile than bonds of de-veloped countries.
Country risk is an important factor to assess with EM bonds.

EM bonds usually entail more currency risk. Corporate governance and investor protection standards are rela-tively lower in some emerging markets than in most developed countries.

Behavioral Finance 4: Pride and regret

( 09 November 2007 / UBS Wealth Management Research)

This Education Note explores the consequences of the loss-aversion mind-set common to most investors and how it can lead to signifi-cantly lower returns in their portfolios.

Behavioral Finance 3: Group Dynamics

( 26 October 2007 / UBS Wealth Management Research)

In this Education Note we examine the effect of groups on the decision-making of individual investors.

Understanding Bonds, Part 8: Inflation-Linked Bonds

( 19 October 2007 / UBS Wealth Management Research)

The coupon of an inflation-linked bond is expressed in real terms and is constant over the life of the bond.
However, coupon payments change as the principal is adjusted by the inflation rate. The principal amount repaid at maturity is the initial principal times the inflation rate over the term of the bond.

Behavioral Finance 2: Selective Perception

( 12 October 2007 / UBS Wealth Management Research)

Even if we think we look at something in a completely unbiased way we selectively perceive what we expect to see In addition we put more trust in information provided by someone we like

Acting against our beliefs makes us feel uncomfortable If we can blame someone else for errors we experience no dissonance

If there is no one to blame we unconsciously adapt our attitudes to justify our decisions to ourselves

Behavioral Finance 1: Introduction

(28 September 2007 / UBS Wealth Management Research)

In this series of Education Notes we explore behavioral influences on investors
decision-making and the effects these have on investment
success

Understanding Bonds, Part 7: Floating Rate Notes

(25 September 2007 / UBS Wealth Management Research)

This Education Note considers bonds with floating coupons and their relative
attractiveness versus fixed-rate bonds

Revisiting the Art of Portfolio Diversification

(20 September 2007 / UBS Wealth Management Research)

This Education Note continues our series on portfolio diversification
We focus here on the question of how many individual stocks make
up a well diversified portfolio within the asset class of equities

UBS WMR Purchasing Power Parity

(20 September 2007 / UBS Wealth Management Research)

Purchasing Power Parity (PPP) is a long-term equilibrium value for an
exchange rate The definition of this equilibrium is based on the notion
that regional price differences for the same goods cannot be
sustained in the long term

What is an Asset Class?

(17 September 2007 / UBS Wealth Management Research)

This Education Note explains our notion of what we think drives asset
classes We provide a definition from the viewpoint of a private
investor that allows classifying investments by their impact they
might have on a portfolio

Understanding Bonds Part 6: Callable Bonds

(31 August 2007 / UBS Wealth Management Research)

A bond that is issued with a "call" provision may be redeemed by the issuer at predetermined times prior to its stated maturity

Companies issue callable bonds if they expect that their cost of debt will decline prior to the bond’s maturity

Call provisions are especially useful for longer-dated bonds

Investing in Emerging Markets Part 1: Equities

(30 July 2007 / UBS Wealth Management Research)

They remain a more volatile segment
Country risk is an important factor
Emerging markets entail greater currency risk
Corporate governance and investor protection standards are lower than in developed markets.

Education Note: Understanding bonds Part 5: Corporate Credit

(25 July 2007 / UBS Wealth Management Research)

The efficiency of portfolios can be increased by adding corporate bonds. The corporate bond market is a mature asset category thatoffers investors a wide range of diversification possibilities.

Investors receive a higher yield on corporate bonds than they do onrisk-free government bonds in order to compensate them for theadditional risks they are assuming.

Corporate bonds can outperform government bonds when the economy is recovering from recession. They can also outperform equities when economic growth is slowing or when balance sheetquality is improving.

Education Note: Understanding Bonds Part 4: European Covered Bonds

(13 June 2007 / UBS Wealth Management Research)

With more than 70 issuers and liquid current assets of more than EUR 800 billion, the bond segment of European covered bonds is now one of the most significant areas of bond trading in Europe.

This Education Note introduces you to the European covered bonds segment and explains why they have been able to establish them-selves so successfully on the capital market and why they continue to grow.

We believe that their high quality and security make covered bonds an attractive option for investors looking for a first class alternative to government bonds with the aim of diversifying their AAA-rated portfolio.

The Art of Portfolio Diversification Part 7: Putting it all together

(06 June 2007 / UBS Wealth Management Research)

In this final part of our series, we show that a disciplined approach to investing can add significant value by avoiding unnecessary risks.

We explain a possible approach to portfolio construction that links previous parts of this series within a well-defined investment process.

"130/30" – A new breed emerging?

(31 Mai 2007 / UBS Wealth Management Research)

At a glance Regulatory changes facilitate the creation of new types of funds and support the integration of classic and hedge fund managers. Here, we analyze one recent innovation, the"130/30" funds. Background

In Europe, the recent UCITS III revisions have relaxed rules governing the usage of derivatives and leverage.

There are two broad types of funds: "relative" and "absolute" return "130/30" is an extension of relative return funds. Opportunities

The revised rules enable fund managers to implement strategies previously not accessible to private investors.

A relaxed portfolio constraint may offer enhanced returns. Risks

Caveat investor! In themselves, relaxed constraints do not assure investment talent.

Relaxed constraints also introduce new kinds of risks . Opinion

Evaluating whether risks are properly rewarded and finding the "best of breed" is crucial

Understanding Bonds Part 3: Not all AAA's are equal

(16 may 2007 / UBS Wealth Management Research)

Rating agencies and credit analysts reward the highest level of credit quality with a AAA rating. Therefore, AAA-rated bonds are often referred to as risk-free investments.

More than 50% of global bond volume is rated AAA. This note takes a closer look at different types of AAA-rated bonds and compares their risk-return profiles from the perspective of a private investor.

We do not think that all AAA's are equal and we suggest weights for types of AAA-rated bonds within a high-quality bond portfolio, depending on the maturity range.

WMR Bond Valuation Methodology and Terminology

(14 May 2007 / UBS Wealth Management Research)

In May 2007, UBS Wealth Management Research (WMR) is launching a series of products designed to provide security-specific recommendations for clients interested in investing in the US bond markets. Security- specific recommendations will complement existing WMR products, including corporate as well as asset strategy reports.

While bonds appearing in our publications will represent our favorite— and least favorite—ideas, they are not meant to be an endorsement of the asset class as a whole. Clients should refer to other publications such as the Fixed Income Strategist for WMR’s outlook for the specific asset class, and consult with their Financial Advisor to determine the appropriateness of fixed income securities as part of a diversified portfolio.

Currency carry strategies

(10 May 2007 / UBS Wealth Management Research)

We examine the potential risks and returns of currency carry trades in this Education Note.

We find that for a well-diversified carry strategy, long-term returns come from differences in real interest rates.

While the carry trade has been a profitable strategy for investors for years, concerns have grown recently, as various exchange rates are at far from fair value, in our view.

Education Note: The Art of Portfolio Diversification (Part 6)

(3 May 2007 / UBS Wealth Management Research)

Please be aware that UBS AG does not provide any tax advice. ThisEducation Note is for informational purposes only. Each reader should consult his or her own tax advisor concerning the tax conse-quences of any investment they make or are contemplating, and should not rely on any tax planning schemes that are discussed herein

Most investors are subject to taxes, so after-tax returns are highly relevant input factors for portfolio optimization.

In this sixth installment of our series on portfolio diversification, we demonstrate the added value that can be achieved if portfolios are diversified with an eye on the expected tax burden.

We show that if capital gains are taxed differently from income, the optimal asset allocation on an after-tax basis differs from a pre-tax basis.

We also show how buy-and-hold investments become more attrac-tive if capital gains tax is lower for long-term investments than for short-term investments.

Finally we show how the use of loss-harvesting techniques and tax-optimized investment vehicles may increase portfolio returns on an after-tax basis.

Understanding Bonds Part 2: How to select bonds

(12 April 2007 / UBS Wealth Management Research)

The purpose of this Note is to help you to select bonds with thegreatest total return potential, given your desired level of risk. We introduce the major drivers of bond performance; Interest rates and credit risk.

While a lower priced (higher yielding) bond may seem relatively at-tractive, such a bond may be cheap for a reason. Therefore, picking the real opportunities also requires a consideration of factors that impact the bond risk premium other than credit risk.

These include liquidity, supply, and taxation. Education Series: Understanding Bonds Topic Publication Date Part 1: What you need to know March 2007

In our discussion, we concentrate on straight bonds. These have a fixed coupon and maturity, and do not include any optionality (e.g. calls or puts). We will explain the deviations from the straight type in Parts 6 to 10 of this Series.

The Art of Portfolio Diversification Part 5: The Influence of Time

(2 April 2007 / UBS Wealth Management Research)

This installment in our series on portfolio diversification looks at a very important factor in the composition of a diversified portfolio: the time horizon of the investment.

We show that an efficient portfolio changes its composition to ex-ploit changes in the behavior of various asset classes over different time horizons.

Over longer time horizons, international diversification and non-traditional assets become attractive means of diversification in terms of their relative risk-return characteristics.

UBS SUMMIT: Short-term Unique Money Market Investment

(29 March 2007 / UBS Wealth Management Research)

Interest rates are highly affected by economic trends or by the decisions of government agencies. Since such information is widely available, many investors might have a clear view over interest rates. For such investors, SUMMITs offer attrac-tive returns based on money market rates in EUR, CHF, USD and GBP.

Although interest rate products are perceived to be complex, it is straightforward to understand SUMMITs: a high return is offered when the investor's view on the evolution of the un-derlying rate becomes true.

Available in two forms, SUMMITs provide higher return po-tential than traditional fixed income products: SUMMIT (Bear-ish view on bonds) for an increasing opinion on rates and SUMMIT (Bullish view on bonds) for a decreasing opinion on rates.

Do You Need All That Cash?

(28 March 2007 / UBS Wealth Management Research)

In our experience investors generally hold too much cash in their portfolios which could be employed more efficiently.

In a more holistic approach to investing, these cash investments should be assessed in a portfolio context and we show that there are easy ways to manage a portfolio's liquidity without losing the safety and liquidity provided by cash investments.

We stress, however, that cash substitutes need to be hedged against possible currency risks.


Finally we show that the results derived for a USD investor qualita-tively also hold for EUR and CHF investors

Understanding Bonds Part 1: What you need to know

(14 March 2007 / UBS Wealth Management Research)

The most traditional asset classes in a portfolio are stocks and bonds. While a company usually has just one type of shares, it may have numerous bonds with very different characteristics.

Shareholders strongly participate in both the positive and negative developments of a company. Bondholders may only see minor price gains following strong performance of the company, but they could lose the whole investment if the company fails. So the bondholder's focus is on risk.

We intend to shed light on this variety of instruments and explain the most important characteristics of bonds. This paper should also assist you in avoiding common traps when selecting bonds.

This is the first part of a series of Education Notes on bonds. Follow-ing this introduction to bond characteristics, we will show you how to select individual bonds for your portfolio in Part 2. Thereafter, we will take a closer look at the major bond segments and special types of bonds in Part 3 to 10.

Taxes on fixed income products for private investors with tax domicile in Switzerland

(09 March 2007 / UBS Wealth Management Research)

Taxation is a crucial aspect for every private investor. Indeed, performance after tax is vital to assess the return of an investment.

The circular recently published by the Swiss Federal Tax Administration does not contain any major changes in taxation principles. Nonetheless, thanks to improved technology, determining whether a product is transparent or not has become easier.

This Education Note presents an up-to-date report on taxes and their calculation for the main fixed income investments. Optimal ways to invest in bonds, derivatives and fixed income structured products will also be discussed.
Our investment conclusions are the following: prefer low-coupon or non-IUP bonds, as well as transparent structured products; make sure that your tax optimization is not perceived as tax avoidance or professional securities trading by tax authorities; keep diversifying your investments in order to maximize your risk-return profile.

Technical analysis: does it add value?

(02 March 2007 / UBS Wealth Management Research)

This Education Note considers the benefits of technical analysis to improve investment portfolio returns.

We show that technical analytical indicators generate signals for trading strategies and timing decisions.

Fundamental indicators seem to outperform over our testing period.

A combined technical and fundamental approach may enhance the risk/return profile of the investment.

The Art of Portfolio Diversification Part 4: Risk Management

(01 March 2007 / UBS Wealth Management Research)

We focus on diversification – investing in a variety of assets – as a way to reduce the risk of any single asset falling short of a predefined investment goal.

Ideally, an investor should minimize shortfall risk through a comprehensive, holistic approach that not only looks at assets but also at liabilities. An ideal framework also considers the changes in an investor's life, because these evolving needs alter financial goals over the course of time.

We also look at extreme events like crashes in our discussion of risk management. Such events create atypical return patterns that are often not represented in standard diversification approaches.

Finally, we discuss the significant risk from estimation error that is inherent in forecasting the future returns and risks of an asset.

International investing from a CHF perspective

(26 February 2007 / UBS Wealth Management Research)

To achieve portfolio efficiency, international diversification (investing in foreign assets) is essential.

However, foreign investments entail currency risks if not fully hedged. So the investor must decide either to take on this risk or to hedge with a forward contract.

Hedging currency risks is more advantageous when investing in cur-rencies with lower interest rates compared to the home currency; it is less favorable in the opposite case, in the long-term.

Complete hedging of currency risk is generally not an optimal ap-proach. For bonds, however, the proportion of hedged funds should normally be higher than for equities.

Currency hedging also depends on the time horizon: the shorter the time horizon, the more favorable it is to hedge currency risk, broadly speaking. However, steering the currency exposure is also an important element of tactical portfolio allocation.

The Art of Portfolio Diversification Part 3: Rebalancing to Control Risks

(02 February 2007 / UBS Wealth Management Research)

Every professionally managed portfolio is rebalanced to its desig-nated benchmark weights from time to time. This is an appropriate means to control the risks of a diversified portfolio.

Since portfolio rebalancing implies selling past winners and buying past losers it also can be seen as a kind of diversification over time.
In this third part of the series on the benefits and limits of diversifi-cation we show that portfolio rebalancing improves portfolio effi-ciency.

Rebalancing is also able to generate additional (though small) re-turns when compared to a portfolio that has not been rebalanced.

The Art of Portfolio Diversification Part 2: Selecting Actively Managed Funds

(08 Januar 2007 / UBS Wealth Management Research)

While part 1 of this series ("The interplay of asset classes" published on November 23, 2006) concentrated on diversification among dif-ferent asset classes based on a passive investment style, this Note investigates how the hunt for alpha by investing in a number of ac-tively managed funds might affect diversification considerations.

Investors try to identify the fund managers that have exceptional skills.

As it is very difficult to separate the skilled from the unskilled man-agers, a multi manager approach might help to diversify the risk of underperformance.

However, as with too many asset classes, too many managers might make things worse when costs are taken into account.