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2018 | Buch

A Primer on Contingent Convertible (CoCo) Bonds Kapitel lesen Erstes Kapitel lesen

The Risk Management of Contingent Convertible (CoCo) Bonds

verfasst von: Dr. Jan De Spiegeleer, Dr. Ine Marquet, Prof. Wim Schoutens

Verlag: Springer International Publishing

Buchreihe : SpringerBriefs in Finance

Enthalten in: Springer Professional "Wirtschaft+Technik" , Springer Professional "Wirtschaft"

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Über dieses Buch

This book provides an overview of the risk components of CoCo bonds. CoCos are hybrid financial instruments that convert into equity or suffer a write-down of the face value upon the appearance of a trigger event. The loss-absorption mechanism is automatically enforced either via the breaching of a particular accounting ratio, typically in terms of the Common Equity Tier 1 (CET1) ratio, or via a regulatory trigger.

CoCos are non-standardised instruments with different loss-absorption and trigger mechanisms. They might also contain additional features such as the cancellation of coupon payments.

Different pricing models are discussed in detail. These models use market data such as share prices, CDS levels and implied volatility in order to calculate the theoretical price of a CoCo bond and its sensitivities, providing the investor with insides to hedge from adverse changes in the market conditions.

The audience are professionals as well as academics who want to learn how to risk manage CoCo bonds using cutting edge techniques as well as all the risk involved in CoCo bonds.

Inhaltsverzeichnis

Frontmatter
Chapter 1. A Primer on Contingent Convertible (CoCo) Bonds
Abstract
The central theme of this book is one financial instrument called a contingent convertible bond or CoCo. CoCo bonds are issued by financial institutions such as banks and (re-)insurance companies. Due to their loss-absorption mechanism, they play an important role in the new regulation guidelines after the financial crisis of 2007–2008. A CoCo bond contains an automatically loss absorption mechanism in times of crisis. This can avoid the use of taxpayers’ money to save a falling financial institution in a crisis.
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Chapter 2. Pricing Models for CoCos
Abstract
Each CoCo bond is different and this lack of standardisation proves to be a real challenge. Also comparing CoCo bonds of different banks against each other is not straightforward. The actual valuation of a CoCo incorporates the modeling of both the trigger probability and the expected loss for the investor. Some would argue that modelling contingent debt is an impossible task. After all, how could one possibly model an accounting trigger taking place or a regulator pulling the non-viability trigger on a CoCo bond? The only CoCos for which an adequate financial model could deliver an acceptable theoretical price would be those with a market trigger. In such a case, the loss absorption mechanism is activated as soon as an observable variable such as for example a share price level or a credit default swap spreads drops below a specified barrier. However none of such CoCo bonds have been issued so far (De Spiegeleer et al. 2014).
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Chapter 3. Sensitivity Analysis of CoCos
Abstract
Knowing and understanding the exposures of different financial instruments is a crucial part of the investment process. These insights are necessary to provide the investor an overview which factors have the largest influence on the price. Once the holder of the financial instrument knows these sensitivities, he/she can start investing in other financial instruments to decrease the overall risk exposure, if he/she finds this appropriate. This procedure is referred to as hedging. In this chapter a sensitivity analysis is provided to explain how moves in the theoretical CoCo price are driven by changes in other market values including the underlying stock, the credit spread and the interest rates.
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Chapter 4. Impact of Skewness on the Price of a CoCo
Abstract
In Chap. 2 the pricing of CoCo notes has been worked out in a market implied Black–Scholes context. However the Black–Scholes stock price model is based on several assumptions that are not related with real financial markets such as normal distributed log-returns with a constant volatility. Under the Black–Scholes model this volatility parameter is assumed to be constant for all vanilla options independent of their maturity dates or strike price. However if we use the Black–Scholes option pricing model, we can compute the implied volatility parameter of the underlying such that the model price does correspond with the market price. On the financial markets we observe different implied volatilities across the various strikes or maturities (see Fig. 4.1). This skewed pattern is referred to as the volatility smile or skew.
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Chapter 5. Distance to Trigger
Abstract
Some argue that the distance between the bank’s current CET1 ratio and the triggering level is irrelevant given the presence of the PONV regulatory trigger. Nevertheless, many market practitioners seem to believe that these buffers of regulatory capital provide a useful tool for a relative valuation.
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Chapter 6. Outlier Detection of CoCos
Abstract
Data mining is an important new topic within the financial world with multiple applications in risk management, trading, marketing etc. For example banks apply data mining in various areas from credit scoring to the pricing of loans. In this chapter the focus is on the detection of observations different from the majority, called outliers. This can be of interest for market analysts, risk managers, regulators and traders. The exceptions might be caused by exceptional circumstances and can require extra hedging or can be seen as trading opportunities. They could as well give regulators an early warning and signal for potential trouble ahead.
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Chapter 7. Conclusion
Abstract
CoCos are hybrid high-yield instruments that contain an automatically triggered loss-absorption mechanism. These securities convert into equity or experience a write-down when the issuing financial institution is in a life-threatening situation. Hence CoCo bonds automatically improve the solvency of the issuing financial institution in times when it would otherwise have difficulties to raise capital levels. Furthermore conversion CoCos automatically increase the equity basis in times of stress.
Jan De Spiegeleer, Ine Marquet, Wim Schoutens
Backmatter
Metadaten
Titel
The Risk Management of Contingent Convertible (CoCo) Bonds
verfasst von
Dr. Jan De Spiegeleer
Dr. Ine Marquet
Prof. Wim Schoutens
Copyright-Jahr
2018
Electronic ISBN
978-3-030-01824-5
Print ISBN
978-3-030-01823-8
DOI
https://doi.org/10.1007/978-3-030-01824-5