The Pricing of Already Issued Contingent Convertible Bonds (Coco-Bonds)

Seminar paper from the year 2011 in the subject Business economics - Banking, Stock Exchanges, Insurance, Accounting, grade: 1,2, University of Innsbruck (Banking and Finance), course: Risk Management, language: English, abstract: 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.