UBS Credit-Linked Note An efficient credit market investment.

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1 UBS Credit-Linked Note An efficient credit market investment.

2 A Credit-Linked Note (CLN) allows you to obtain credit exposure to a wide variety of underlying entities in order to enhance the return on the fixed income part of your investment portfolio. The characteristics of a Credit-Linked Note resemble those of a regular corporate bond, both in terms of cash flow and associated credit risk. The issuer of a CLN issues a note that is linked to the credit of one or more reference entities. The term credit refers to the possibility of a loss due to the failure by an entity to meet its contractual obligations of timely interestpayment and repayment of notional. The holder of a CLN has credit exposure to the issuer of the notes as well as to the reference entity or entities as defined in the terms and conditions of the CLN. By purchasing a CLN you are effectively selling credit protection in relation to the reference entity or entities. In return you receive a coupon representing the premium paid by the buyer of credit protection. While a bond-investor bears the credit risk of the issuer of the debt instrument he physically holds, a CLN gives you synthetically exposure to the occurrence of predetermined credit events* in relation to underlying entities. Main advantages at a glance Diversification: CLNs enable you to access and take credit exposure to a wide range of reference entities without actually having to hold bonds issued directly by such reference entities. Tailored bond: CLNs enable you to tailor the key components of your CLN: reference entity/ entities, leverage, coupon, maturity, price, etc. Rating and listing: CLNs may be assigned ratings by the rating agencies and may be listed on a variety of stock exchanges. Spread pick-up over cash: You may get a higher yield than a direct holding of a bond issued by the same reference entity with an equivalent maturity. Leverage: You can add different degrees of leverage to a basket of reference entities, by applying the Nth-to-Default structure. If no credit event occurs during the term of the CLN, it is redeemed on its maturity date at its nominal amount. CLNs may be Single Name CLNs, Basket CLNs or Nth-to-Default CLNs. * It is important to note that the definition of a credit event is wider than that of a bond default and as such, it is possible that a credit event is triggered without there being a bond default. The most common credit events, as defined in the 2003 Credit Derivatives Definitions published by the International Swaps and Derivatives Association (the 2003 Definitions ) in relation to corporate entities are bankruptcy, failure to pay and restructuring. Single Name CLN A Single Name CLN is the most straightforward CLN as it references only one reference entity. If no credit event occurs during the lifetime of the CLN, you will receive a coupon (established upon the issue date of the CLN). At maturity of the CLN, you are paid the principal. If a credit event occurs prior to maturity date of the CLN, no further coupon payments will be paid and the Single Name CLN will be redeemed by payment to you of an amount equal to the market value of obligations issued by the reference entity (cash redemption). Example of a Single Name CLN You are an investor in fixed coupon bonds of entity A. With interest rates having fallen over the past few years, your bonds are trading well above par. You now expect interest rates to start rising again and would therefore like to exchange your fixed coupon bonds for variable coupon bonds from the same issuer. Apart from the desired reduction in duration, you could realize a sizeable book profit. Your problem is that there are no suitable floating rate notes of entity A in the market. You acquire a 5-year EUR-denominated UBS CLN with reference entity A and a 6-month EURIBOR % floating rate. Both issue price and redemption price are at 100% (provided no credit events have occurred). This CLN enables you to achieve your investment objectives, because you realize the accrued book value on your existing bond and you protect yourself from rising interest rates by means of a variable coupon.

3 Basket Credit-Linked Note (Basket CLN) Basket CLN references a basket of reference entities. s will receive a coupon (established upon the issue date of the CLN) until the earlier of the maturity date of the CLN or the date on which credit events have occurred in respect of every reference entity. If a credit event occurs the nominal amount of the CLN will be reduced by the same proportion as the relevant reference entity bears to the basket and the investor will be paid an amount equal to the recovery value of outstanding obligations issued by the relevant reference entity (cash redemption). Thereafter, as the nominal amount of the CLN has been reduced, coupon payments will be reduced proportionally and the coupon rate may be reset. As the Basket CLN is not terminated following a credit event, the remaining nominal capital continues to be exposed to potential credit events throughout the remaining term. With a Basket CLN, the loss potential per reference entity is limited to the proportional weighting of each reference entity within the basket. In other words, if there are five equally weighted entities in the Basket CLN, an investor can lose a maximum of 20% (minus recovery value) of the nominal capital per credit event. Cash flow diagram of a Basket CLN Example of a Basket CLN You are an investor in a UBS credit-linked note with reference entity A (see example below). You appreciate the reduction in duration achieved as well as the book gains you cashed in when you switched from the cash bond into the CLN. However, in the meantime you feel less bullish on the automotive sector and rather than to put all eggs in one basket you would prefer to diversify your credit exposure over several industry sectors; at low cost and without comprising on the quality of your credit exposure (investment grade only). You are comfortable to take on credit exposure for three years. You are still expecting interest rates to rise in the foreseeable future. A three-year EUR-denominated CLN with reference entity A (e.g. from automotive sector with A3/BBB, entity B (e.g. a Bank with Aa3/AA-), entity C (e.g. from chemical sector with Aaa3/AA-), entity D (e.g. from electronic sector with Aa3/AA-) and E (e.g. insurance company with Aa3/A+) would solve this dilemma. Issue price and redemption price are at 100% (provided no credit events have occurred); the coupon would be 6-month EURIBOR +0.20%. This CLN enables you to achieve your investment objectives: Initial flows Reference portfolio Entity A B C D E EUR 2m 2m 2m 2m 2m EUR 10m Basket CLN EUR 10m You obtain a spread-over EURIBOR of 20 bps You diversify your credit exposure You limit your credit risk to entities rated BBB or better Ongoing flows Fixed rate or EURIBOR + ( ) bps 5 EUR 2m default protection You protect yourself from rising interest rates by means of a variable coupon Fixed rate or EURIBOR + ( ) bps Nominal amount reduction (e.g. reference entity B defaults) 4 EUR 2m default protection 100% Market Value of EUR 2m notional debt obligation of Reference Entity B (EUR 2m Basket CLN redeemed)

4 Nth-to-Default Credit-Linked Note (NTD CLN) An NTD CLN is a note, which references a basket of reference entities. The difference between a Basket CLN and a NTD CLN is that upon the occurrence of a predetermined number of credit events in relation to the reference entities the entire NTD CLN terminates whereas the Basket CLN continues with a reduced nominal amount (as described above). A first-todefault CLN would terminate after one reference entity would suffer a credit event, a second-to-default after two reference entities would suffer a credit event, etc. In contrast to a Basket CLN, with an NTD CLN the loss potential per reference entity is not limited to the proportional weighting of each reference entity within the basket but instead to the entire nominal amount of the NTD CLN. When a credit event occurs in respect to the Nth reference entity in the basket, no further coupon payments will be paid to the investor and the NTD CLN will be redeemed by payment to the investor of an amount equal to the market value of obligations issued by the relevant reference entity (cash redemption). In other words, in the case of an NTD CLN, the investor could lose a maximum of 100% (and not just 20%) of the nominal amount when one reference entity experiences a credit event even if there are five entities in the NTD CLN. Cash flow diagram of an NTD CLN Initial flows Ongoing flows Early termination (e.g. reference entity B defaults) Reference portfolio Entity A B C D E EUR 10m 10m 10m 10m 10m EUR 10m FTD Note EUR 10m Fixed rate or EURIBOR + ( ) bps EUR 10m default protection Cas recovery value of EUR 10m Notional of ref. entity B EUR 10m FTD note redeemed Example of a Basket NTD CLN You are an experienced investor in debt instruments and also actively follow the credit risk market. Because of your firm expectation that interest rates will rise, you have no wish at present to commit yourself to fixed interest-bearing investments over the longer term. Your investment horizon is currently restricted to a maximum of 36 months. You do not like to invest in issues with a credit rating below BBB, but you will consider a leveraged investment. You seek an attractive variable rate investment alternative with short maturity that offers a coupon on a Libor plus basis despite the short duration. You are prepared to accept, for the limited duration of three years, a combined (leveraged) credit risk of selected investment grade issuers since you have a clear opinion regarding these entities short-term credit quality prospects. You acquire a EUR-denominated 3-year UBS NTD CLN on the reference entities A (A3/BBB), B (Aa3/AA-), C (Aaa3/AA-), D (Aa3/AA-) and E (Aa3/A+). The coupon is a 6-month EURIBOR %. Both issue price and redemption price are at 100% (provided no credit events have occurred). This NTD CLN enables you to achieve your investment objectives: You obtain a spread-over EURIBOR of 50 bps You limit your individual credit risk to entities rated BBB or better You protect yourself from rising interest rates by means of a variable coupon s should note that the above charts and examples are purely for illustrative purposes and do not give any indication of actual conditions or profits. These examples do not take account of dividend payments or standard securities trading costs (brokerage, etc.).

5 Risks Combined credit risk: As a CLN is a debt instrument, you assume both credit risk of the relevant reference entity or entities and the issuer of the CLN. Market risk: When the credit risk premia on obligations of the reference entity (entities) rise, the bond price may fall below 100%. In NTD CLN where you as investor are exposed to leveraged credit exposure, the sensitivity to widening credit spreads is even more pronounced. Coupon risk: Coupon payments on a Single Name CLN terminate as soon as the underlying reference entity suffers a credit event. Coupon payments on a Nth-to-Defaults will cease as soon as the Nth reference entity in the basket suffers a credit event. If a reference entity in a Basket CLN suffers a credit event, the coupon will be reset and is paid on the reduced nominal amount. The residual capital and coupon are exposed to further credit events. profile and suitability You are an experienced investor and follow current developments in the bond and credit markets. As an investor, you are in a position to assess not only the potential return but also the risk of loss. You already hold a portfolio of various bonds and would like both to improve performance and to diversify your issuer risk. You do not expect any credit events in respect of the reference entities during the specified product term. You understand that this is a buy-and-hold product and, given the high hedging costs, a greater bid/ask spread cannot be ruled out in the event of a sale during the term. You understand that in an extreme scenario you may lose your invested capital. Notional risk: If a credit event occurs it is likely that you will receive a redemption payment that is less than the amount of your initial investment or in the case of a Basket CLN, a proportion of your initial investment*. * Whether redeemed through cash redemption or physical redemption, the redemption payment will be based on the value of the obligations of the relevant reference entity at the time of redemption. As distressed obligations have a market value that may be considerably less than par, it is likely that investors will receive a redemption payment that is less than the amount of their initial investment. This product is exposed to the risks associated with all structured products. For further information please read carefully the UBS brochure Special Risks in Securities Trading or contact your client adviser.

6 This brochure is for information purposes only and does not constitute an offer, a solicitation or a recommendation to buy or sell any specific product. While all the information provided herein has been obtained from reliable sources; we cannot accept any liability for its accuracy. Structured transactions are complex and may involve a high risk of loss. This publication does not take into account the particular investment objectives, financial situation and needs of our individual clients. Prior to entering into a transaction you should consult with your own legal, regulatory, tax, financial and accounting advisors to the extent you consider it necessary, and make your own investment, hedging and trading decisions (including decisions regarding the suitability of this transaction) based upon your own judgement and advice from those advisers you consider necessary. Save as otherwise expressly agreed, UBS is not acting as your financial adviser or fiduciary in any transaction. Please note that telephone calls made to the number marked with an * may be recorded. If you call these numbers we will assume that you agree to this business practice. UBS AG Marketing Structured Products P.O. Box, CH-8098 Zurich Phone: *, fax: derivatives@ubs.com, UBS Investment Bank is a business group of UBS AG This environmentally friendly paper has been produced using pulp bleached without chlorine. Printed in Switzerland, June E