In the year 2007 one of the biggest financial crisis in worlds history has begun. It
leads to the bankruptcy of huge financial institution followed by the bailout of banks
through the national government and a downturn in worldwide stock markets. The
financial crisis has also shown that the capitalizations of numerous financial institutes
were not adequate and several components of banks equity could not fulfil their
planned function. To save the global financial system from collapsing many banks
received lot of money from the government.
To avoid another future crisis and huge bailouts by the national government, some
financial experts and leading economists proposed a new financial instrument, called
Contingent Convertibles Bonds (“CoCo-Bonds”). They are considered to be an
opportunity to improve the equity base of banks in times of crisis. CoCo-Bonds are a
special form of bonds, which convert automatically to equity after a predefined
incidence.
Three large banks have already issued these new financial instruments; The Lloyds
Banking Group (2009), Rabobank (2010) and the Credit Suisse (2011). The aim of
this paper is to analyse the structure and the pricing of these already issued CoCo-
Bonds. In the first part the functionality of the CoCo-Bonds will be explained. It will
also provide a summary of the specification of the already issued CoCo-Bonds. The
third part, which is the main part, is focused on the pricing modalities of these new
financial instruments. Two different approaches will be considered. First the credit
derivatives approach and seconds the equity derivatives approach. In the end of the
paper both approaches will be applied to the already issued CoCo-Bonds of Lloyds
and Credit Suisse.
Inhaltsverzeichnis (Table of Contents)
- I Introduction
- II The Mechanism of CoCo-Bonds
- 2.1 Backgrounds and functionality
- 2.2 Definition of the Trigger Event
- 2.2.1 The Market Trigger
- 2.2.2 The Accounting Trigger
- 2.2.3 The Regulatory Trigger
- 2.2.4 The Multi-Variante Trigger
- 2.3 The Specification of a Conversion
- 2.3.1 The conversion fraction (a)
- 2.3.2 The conversion ratio C, and the conversion price Cp
- 2.4 The Specifications of already issued CoCo-Bonds
- III The Pricing of CoCo-Bonds
- 3.1 Introduction
- 3.2 The Credit Derivatives Approach
- 3.2.1 The Loss
- 3.2.2 The Trigger Intensity Trigger
- 3.3 The Equity Derivative Approach
- 3.3.1 The Pricing of a Zero Coupon CoCo-Bond
- 3.3.2 The Pricing of a CoCo-Bond with Coupons
- 3.4 Calculation Examples on the Basis of already issued CoCo-Bonds
- 3.4.1 Example for the Credit Derivatives Approach (Case Study Credit Suisse)
- 3.4.2 Example for the Equity Derivatives Approach (Case Study Lloyds)
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
The objective of this paper is to analyze the structure and pricing of already issued Contingent Convertible Bonds (CoCo-Bonds), focusing on two different pricing approaches: the credit derivatives approach and the equity derivatives approach. The paper examines the functionality of CoCo-bonds and their specifications, using examples from Lloyds and Credit Suisse.
- Functionality and Structure of CoCo-Bonds
- Definition and Types of Trigger Events for Conversion
- Credit Derivatives Approach to CoCo-Bond Pricing
- Equity Derivatives Approach to CoCo-Bond Pricing
- Case Studies of Already Issued CoCo-Bonds
Zusammenfassung der Kapitel (Chapter Summaries)
I Introduction: This introductory chapter sets the stage by discussing the 2007 financial crisis and its impact on the capitalization of financial institutions. It highlights the need for new financial instruments to improve bank equity and prevent future bailouts. The chapter introduces CoCo-Bonds as a solution and outlines the paper's aim to analyze their structure and pricing, focusing on examples from Lloyds Banking Group, Rabobank, and Credit Suisse. The chapter emphasizes the innovative nature of CoCo-bonds as hybrid instruments bridging debt and equity.
II The Mechanism of CoCo-Bonds: This chapter delves into the mechanics of CoCo-Bonds, explaining how they automatically convert to equity upon reaching a predefined trigger event. It contrasts CoCo-Bonds with traditional convertible bonds, highlighting the automatic nature of conversion in CoCo-Bonds and the implications for investors and the issuing institution. The chapter details the different types of trigger events (market, accounting, regulatory, and multi-variant) that can initiate the conversion. It further explains the specifications of conversion, including the conversion fraction and ratio, providing a crucial understanding of the bond's behavior under various conditions.
III The Pricing of CoCo-Bonds: This chapter forms the core of the paper, presenting two different approaches for pricing CoCo-Bonds: the credit derivatives approach and the equity derivatives approach. Each approach is thoroughly explained, detailing the underlying assumptions and calculations. The chapter provides calculation examples based on already issued CoCo-Bonds from Lloyds and Credit Suisse, illustrating the practical application of both methods. This comparative analysis allows for a comprehensive understanding of the different methodologies and their applicability in valuing this complex financial instrument. The chapter uses real-world case studies to demonstrate the application of theoretical frameworks, strengthening its practical relevance.
Schlüsselwörter (Keywords)
Contingent Convertible Bonds (CoCo-Bonds), hybrid financial instruments, debt-equity swap, trigger events, conversion, pricing models, credit derivatives, equity derivatives, financial crisis, bank capitalization, risk management, Lloyds Banking Group, Credit Suisse.
Frequently Asked Questions: A Comprehensive Language Preview of Contingent Convertible Bonds (CoCo-Bonds)
What is the main objective of this paper?
The paper aims to analyze the structure and pricing of already issued Contingent Convertible Bonds (CoCo-Bonds), focusing on two distinct pricing approaches: the credit derivatives approach and the equity derivatives approach. It uses examples from Lloyds and Credit Suisse to illustrate these approaches.
What are the key themes explored in this paper?
The paper explores the functionality and structure of CoCo-Bonds, different types of trigger events for conversion, the credit derivatives approach to CoCo-Bond pricing, the equity derivatives approach to CoCo-Bond pricing, and includes case studies of already issued CoCo-Bonds.
What are Contingent Convertible Bonds (CoCo-Bonds)?
CoCo-Bonds are hybrid financial instruments that function as debt until a predefined trigger event occurs, at which point they automatically convert into equity. This conversion aims to improve bank equity and prevent future bailouts, addressing concerns raised after the 2007 financial crisis.
What types of trigger events are discussed for CoCo-Bond conversion?
The paper details four types of trigger events: market trigger, accounting trigger, regulatory trigger, and multi-variant trigger. These events determine when a CoCo-Bond converts from debt to equity.
What are the two main pricing approaches for CoCo-Bonds examined in the paper?
The paper explores two pricing approaches: the credit derivatives approach and the equity derivatives approach. Each approach is explained, with calculations and examples provided using real-world data from Lloyds and Credit Suisse CoCo-Bonds.
How are the pricing approaches applied in practice?
The paper includes calculation examples based on already issued CoCo-Bonds from Lloyds and Credit Suisse, demonstrating the practical application of both the credit derivatives and equity derivatives approaches. These case studies strengthen the practical relevance of the theoretical frameworks presented.
What specific CoCo-Bond specifications are detailed?
The paper details the specifications of conversion, including the conversion fraction (a), the conversion ratio (C), and the conversion price (Cp). Understanding these specifications is crucial to grasping the behavior of CoCo-Bonds under different conditions.
What is the significance of the 2007 financial crisis in the context of this paper?
The 2007 financial crisis is highlighted as a pivotal event that underscored the need for new financial instruments, like CoCo-Bonds, to improve bank capitalization and prevent future government bailouts.
What are the key differences between CoCo-Bonds and traditional convertible bonds?
Unlike traditional convertible bonds, CoCo-Bonds have an automatic conversion feature triggered by pre-defined events. This automatic conversion has significant implications for both investors and the issuing institution.
What are the key words associated with this paper?
Key words include: Contingent Convertible Bonds (CoCo-Bonds), hybrid financial instruments, debt-equity swap, trigger events, conversion, pricing models, credit derivatives, equity derivatives, financial crisis, bank capitalization, risk management, Lloyds Banking Group, and Credit Suisse.
- Quote paper
- Melanie Prossliner (Author), 2011, The Pricing of already issued Contingent Convertible Bonds (CoCo-Bonds), Munich, GRIN Verlag, https://www.grin.com/document/207354
