[MUSIC] Let's have a look at the first of these tools which Jones to used at that's leverage. How does it work? The basically leverage is a performance booster. The idea is that, on top of the assets which you own and you're going to invest, you borrow some additional assets and you also invest these. So altogether you will be making money on a larger pool of assets, yours plus the ones you borrow, and this is how you boost performance. So let's have a look, here, with this example. Basically, you have 100, say it's $100,000 in your hedge-fund. And you make 10% at the end of the year. So you win $10,000. Now, this is without leverage. Now, you want to increase the performance so you do this by borrowing an additional 100. So you're not investing 100 but you are investing 200. 100 you own plus the 100 you borrowed and you are still making the same 10% in your underlying investment. But now 10% of 200 is 20 and the 20 once you put them in relation to your own capital, once you've refunded the 100 you borrow, is actually 20%. So you see that basically with leverage you boost your return by a factor of two. So what was initially 10% has become 20%. So this is how you increase performance for leverage is by borrowing funds and investing those funds. The problem with leverage is that it works both ways. If it goes out by 10% with leverage, you can double the money but you can also double the losses if the underlying assets falls by 10% and your leverage with a factor of 2 and you can lose 20% instead of 10. Now, quiz to you. Is leverage equal to risk? As we see that basically with leverage you're boosting the returns or the losses. Can we equate that with the notion of risk? And here I give you one quiz that you need to answer. Remember this formula we showed, that gives you the link between interest rate risk and the bond price? So the formula with the duration. Well, here, I'll give you two examples, I say, what is riskier for you? Is it a bond portfolio with a duration of ten and no leverage? Or is it a bond portfolio with a duration of one and a leverage of five? So in one case, you're managing a bond portfolio with no leverage, but just a very long duration, ten. And in the second case, you're managing a bond portfolio which is very low risk, a duration of one. So a very low sensitivity to changes in interest rates, but you're gearing it by five times. You're using a leverage of five times. By the way, how much are you borrowing to get a leverage of five? Don't say it's 500. If you're managing 100, it's not 500, it's actually 400. So you have 100, you borrow 400. And that makes a total of 500, which you are investing in this bond portfolio. So this is a gearing, or a leverage of five. So what is risk here for you. All right, so you answered the quiz. Hopefully, you got the right answer. So just to do an analogy, for you to really understand the difference between leverage and risk. Take a look at these two pictures. I ask you the following question now. Is it riskier to drive on this motorway at 130 km/h, or is it riskier to drive on this very icy and snowy road in the mountains at 80 km/h? Now, some people may notice that on the first picture there's actually a camera. And given that the speed limit, at least in Switzerland, is 120 kilometers per hour, it can be somewhat risky. But let's leave this issue on the side and then let's say it's 120 and we're not 130 kilometers per hour. So clearly you get a sense of where I want to get to. It's actually riskier to drive 80 kilometers per hour on this icy road than at 120 on the very dry motor wave where no cars in it. So basically, global risk is a function of underlying conditions which record road conditions. The underlying market and volatility of this market. And the leverage, and leverage is the car speed. So you can use a lot of leverage. If the underlying assets does not bear a lot of risks, so it's very dry motorway. So the global risk will not be very high. Conversely, you can drive very slowly so not, or reasonably slowly, let's say 60 kilometers per hour. But the road is very, very icy so the risk of the, the underlying risk is high, so even that 60 kilometer or 80 kilometer per hour may actually mean that the global risk is actually very high. [MUSIC] Okay.