Determinants of the Interest Rate Premium on Contingent Convertible Bonds (CoCos)
Abstract Ruling out default prior to conversion of high-trigger (going-concern) CoCos, this paper concentrates on estimating the conversion risk premium on CoCos. It does so by estimating the cost of hedging that risk with a contingent put option, exercisable only in the event of conversion, whose strike price is set at the conversion price per share (CPS). In this situation, the level of the common equity tier-1 (CET1) capital ratio at the time that the CoCos are issued plays a central role: it determines the probability of conversion during the term of the CoCos and the level of the CPS, relative to the market price per share (MPS) at the time of CoCos issuance, that must be set to stabilize the expected replacement rate, here at 80%. This replacement rate implies that CoCos holders can expect to lose 20% of the face value of CoCos in the event of conversion and are moved to exercise debt discipline. At the same time, existing shareholders derive sufficient comfort from conversion, for the losses leading up to it, not to oppose the issuance of CoCos in the first place. If the issuing companies have initial Basel III-based capital ratios that are at least 3 percentage points above the 7% going-concern trigger, covering the conversion risk should cost only a third as much as the average premium now required on equity into which, upon conversion, the CoCos would turn. By issuing such CoCos, banks can thus equip themselves with a form of contingent equity line. That line is activated automatically when triggered by adversity to rebuild their capital at a bargain without causing dilution for existing shareholders.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
Volume (Year): 1 (2013)
Issue (Month): 2 ()
|Contact details of provider:|| Postal: |
Phone: +44 20 7951 2000
Web page: http://www.gfsi.ey.com/
When requesting a correction, please mention this item's handle: RePEc:ris:jofipe:0022. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Prof. Shahin Shojai)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.