Trigger Event

(Core Tier 1)
Assets
Contingent
Capital
Senior Debt
Equity
Assets
Senior Debt
Equity

Probability to default density = equation for first exit time used in

barrier option pricing under Black-Scholes
Coco = Zero Coupon Corporate Bond (bond part)
+ knock-in forward (share in case of conversion)
- Binary Down and In options (coupon)

Assets

t

Deposits

t

Coco-Bond

Equity

t

Bank Balance Sheet

t

t

t

t
=
t
+ +
t
L
t
A
t

A
t
-
t
A
t

The risk free rate

t
=
t

t

t
+
t

t

t
+
t
+
q
t

t


q
t

t
:

t
:
~
= |
q
t
]:

t
= _

q
t
= 1 =

q
t
= u = 1

=
pdt
dz

t
=
t
+

t

200 400 600 800 1000 1200
0
2
4
6
Time
I
n
t
e
r
e
s
t

R
a
t
e

[
%
]
Evolution of Interest Rate Payments

> u
> 1

t
=
A
t

t
=
t

200 400 600 800 1000 1200
80
85
90
95
100
105
110
Time
B
a
l
a
n
c
e

S
h
e
e
t

C
o
m
p
o
n
e
n
t
s

S
i
z
e

[
-
]
Evolution of the Balance Sheet Components


Assets
Deposits

200 400 600 800 1000 1200

2
4
6
8
10
Time Step [Days]
C
o
r
e

T
i
e
r

1

R
a
t
i
o

[
%
]
Trigger Ratio and Conversion


Trigger Ratio
Trigger Limit
200 400 600 800 1000 1200
0
20
40
60
80
100
Time Step [days]
B
a
l
a
n
c
e

S
h
e
e
t

C
o
m
p
o
n
e
n
t
s

S
i
z
e

[
-
]
Evolution of the Balance Sheet Components


Assets
Equities
Contingent Capital
Deposits
Trigger event
L
t
A
t

A
t
-
t
A
t

L
t
A
t
< u
0%
5%
10%
15%
20%
25%
30%
35%
Core Tier 1 Core Tier 2 Without
B
a
n
k
r
u
p
t
c
y

L
i
k
e
l
i
h
o
o
d

Trigger Type
Bankruptcy Likelihood
1 Crisis per year
0.5 Crisis per year
0.1 Crisis per year

0
=

0
=

|
-
s
ds
t
0

t

1
0
]

= 2

Assets
[bio CHF]
Deposits
[bio CHF]
Coco-Bond
[bio CHF]
Equity
[bio CHF]
1,000 909.1 2 88.9
Conversion
Share
Issuane
Date
Expiration
Date
Coupon
rate
Trigger
Trigger
Limit
80%
January
2011
2041 7.875% Core Tier 1 7%
Asset Volatility [% p.a.]
O
c
c
u
r
e
n
c
e

o
f

C
r
a
s
h

p
.
a
.

[
%
]


0.5 1 1.5 2 2.5 3 3.5 4
20
40
60
80
100
120
140
160
90
95
100
105
110
115
120
125
130
135
140
The NPV cannot go lower
than the nominal times the
conversion share (80)
Without risk of conversion, the
Net Present Value is the one of
a non-convertible bond with
negligible risk of default
C
u
r
r
e
n
t

P
r
i
c
e

(
S
e
p
t

1
3
t
h

2
0
1
2
)

60 80 100 120 140 160 180 200

0
5
10
15
20
25
30
Fair Issue Price
P
e
r
c
e
n
t
a
g
e

200 400 600 800 1000 1200

2
4
6
8
10
Time Step [days]
T
r
i
g
g
e
r

R
a
t
i
o

[
%
]
Trigger Ratio and Conversions


Trigger Ratio
Coco Triggered
Trigger Limit
The Coco is fully converted and
the ratio Core Tier 1 Ratio can
now go under the trigger limit
The CoCo is triggered as many
times as required to keep the
ratio above the trigger limit
CoCo Type Bankruptcy [%]
CoCo Fully
Converted [%]
Core Tier 1 Full
Conversion
3.7% 75.1%
Core Tier 1 Partial
Conversion
3.4% 17.3%

Forward looking
simulation
(ex ante)
Backward real data
(ex post)
Volatility p.a. 16% 20%

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29
70
80
90
100
110
120
130
140
150
Year
P
r
i
c
e
Price scenarios of a CoCo bond
0 200 400 600 800 1000 1200
0
2
4
6
8
10
12
Time Step [days]
B
a
l
a
n
c
e

S
h
e
e
t

C
o
m
p
o
n
e
n
t
s

[
-
]


Share Price
Equities
Nb Of Share

R
=
B
L
t

R

t
Jump in Equity
No jump in Share Price
t
R
E
B
C
200 400 600 800 1000 1200
0
2
4
6
8
10
12
Time Step [days]
B
a
l
a
n
c
e

S
h
e
e
t

C
o
m
p
o
n
e
n
t
s

[
-
]


Share Price
Equities
Total Nb Of Share
0 200 400 600 800 1000 1200
0
2
4
6
8
10
Time Step [days]
B
a
l
a
n
c
e

S
h
e
e
t

C
o
m
p
o
n
e
n
t
s


Share Price
Equity
Total Nb of Shares

R
>
B
L
t
Jump in Equity
Drop in Share Price:
Old shareholders lose money with the conversion
Sells shares before conversion
Forces conversion

R
<
B
L
t
Jump in Equity
Jump in Share Price
Value Transfer from CoCo holders to shareholders
Shareholders are interested in conversion
Shareholers are interested in health decrease of the bank

Parameter Value Description

1 month Simulation time step
1/12 Probability that a crash occurs be between and +

0.02 The volatility of the lognormal distributed amplitude of the crash return

-0.01 The mean of the lognormal distributed amplitude of the crash return
0.114 The speed factor for the mean reversion adjustment
0.069 The long term target interest rate

0.07 The volatility of the interest rate

-0.2 The correlation between interest rate and asset volatility
0.5 The speed factor for the mean reversion of the asset to deposit ratio
1.1 The target asset to deposit ratio
Parameters from: Pennachi G., 2011, A Structural Model of Contingent Bank Capital

t
=
t
+
t
max

t

q
t

t
, u
t

t
=
t
max

t

q
t

t
, u

t
=
1

t

Y
+
1
2
c
Y
2
(
2
)

1
=
ln
t
+

2
=
1
+