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Contribution Details
| Type | Bachelor's Thesis |
| Scope | Discipline-based scholarship |
| Title | On the Determination of the Fair Price of Contingent Convertible Bonds |
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| Institution | University of Zurich |
| Faculty | Faculty of Economics, Business Administration and Information Technology |
| Date | 2011 |
| Zusammenfassung | Initial problem: The regulatory environment demands always higher capital requirements of financial institutions. The first international pact to introduce minimum capital requirements was signed in 1988 and is known as the Basel I accord. Despite of these minimum requirements financial crisis were not averted. Therefore the capital requirements were improved under Basel II: Risky assets must be protected with more regulatory capital than less risky assets. Basel II was completely introduced at the beginning of 2008. Since the huge financial crisis in 2008 we know, that even this risky capital approach is not the final solution and is not enough to avoid crisis. The hybrid instruments which can be converted to equity by the holders have completely failed in 2008. Because the hybrids were non-mandatory no hybrids were converted into equity during the crisis and the financial institutions had to purchase capital exactly then when it was the most expensive. Due to this the idea of new hybrid instruments with a mandatory conversion came up, the idea to introduce Contingent Convertible Bonds, also called CoCos. These instruments will play an important rule in the new Basel III accord, which is introduced in 2013. The estimations about the CoCo market size go up to USD 1 trillion. The size of the CoCo market is also dependant on the exact rules for regulatory capital, which are defined in July 2011. It is expected that the most important feature of the CoCo bonds must be their loss-absorbance, which was missing for the old hybrids in the last crisis. The big problem with CoCos is their modelling, because the trigger point is not directly dependant on the share price development, but on the Tier 1 ratio. Therefore researchers like J. P. Morgan model the Tier 1 ratio as a function of the share price, what is theoretically wrong. By modelling the CoCo bonds value with the binomial model there are the additional problems with the time value of money and the profit estimations. The arbitrage condition must always be maintained, what leads to some problems mentioned in chapter 7.7.5. Results The results are illustrated in a sensitivity analysis in chapter 8, where the influence of the single factors can be seen. First the value of the CoCos is strict monotone decreasing if the share price volatility increases, what results in a concave curve in the illustration. Second the influence of the interest rate to the CoCo value is decreasing too, but with a convex curve. It has to be mentioned that the influence of the interest rate remains nearly the same for the different CoCos, which were analysed. Third our model reveals that the CoCo value is not dependant on the initial share price. For the other analysed factors, like trigger point and profit volatility, the results are not significant, due to the violations of the arbitrage conditions in two models. |
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