The Handbook of Hybrid Securities
Convertible Bonds, CoCo Bonds, and Bail-In
Wiley Finance Series
1. Edition March 2014
408 Pages, Hardcover
Wiley & Sons Ltd
Introducing a revolutionary new quantitative approach to hybrid
securities valuation and risk management
To an equity trader they are shares. For the trader at the fixed
income desk, they are bonds (after all, they pay coupons, so what's
the problem?). They are hybrid securities. Neither equity nor debt,
they possess characteristics of both, and carry unique risks that
cannot be ignored, but are often woefully misunderstood. The first
and only book of its kind, The Handbook of Hybrid Securities
dispels the many myths and misconceptions about hybrid securities
and arms you with a quantitative, practical approach to dealing
with them from a valuation and risk management point of view.
* Describes a unique, quantitative approach to hybrid valuation
and risk management that uses new structural and multi-factor
models
* Provides strategies for the full range of hybrid asset classes,
including convertible bonds, preferreds, trust preferreds,
contingent convertibles, bonds labeled "additional Tier 1," and
more
* Offers an expert review of current regulatory climate regarding
hybrids, globally, and explores likely political developments and
their potential impact on the hybrid market
* The most up-to-date, in-depth book on the subject, this is a
valuable working resource for traders, analysts and risk managers,
and a indispensable reference for regulators
1.1 Introduction 1
1.2 Hybrid Capital 1
1.3 Preferreds 4
1.4 Convertible Bonds 7
1.5 Contingent Convertibles 9
1.6 Other Types of Hybrid Debt 10
1.7 Regulation 20
1.8 Bail-In Capital 22
1.9 Risk and Rating 24
1.10 Conclusion 25
2 Convertible Bonds 27
2.1 Introduction 27
2.2 Anatomy of a Convertible Bond 30
2.3 Convertible Bond Arbitrage 51
2.4 Standard Features 65
2.5 Additional Features 82
2.6 Other Convertible Bond Types 88
2.7 Convertible Bond Terminology 95
2.8 Convertible Bond Market 102
2.9 Conclusion 106
3 Contingent Convertibles (CoCos) 107
3.1 Introduction 107
3.2 Definition 109
3.3 Anatomy 110
3.4 CoCos and Convertible Bonds 121
3.5 CoCos and Regulations 125
3.6 Ranking in the Balance Sheet 150
3.7 Alternative Structures 151
3.8 Contingent Capital : Pro and Contra 152
4 Corporate Hybrids 159
4.1 Introduction 159
4.2 Issuer of Hybrid Debt 160
4.3 Investing in Hybrid Debt 160
4.4 Structure of a Corporate Hybrid Bond 161
4.5 View of Rating Agencies 170
4.6 Risk in Hybrid Bonds 170
4.7 Convexity In Hybrid Bonds 173
4.8 Equity Character of Hybrid Bonds 177
5 Bail-in Bonds 181
5.1 Introduction 181
5.2 Definition 183
5.3 Resolution Regime 184
5.4 Case Studies 191
5.5 Consequences of Bail-in 195
5.6 Conclusion 197
6 Modeling Hybrids : An Introduction 199
6.1 Introduction 199
6.2 Heuristic Approaches 200
6.3 Building Models 205
6.4 How many factors ? 213
6.5 Sensitivity Analysis 217
7 Modeling Hybrids: Stochastic Processes 225
7.1 Introduction 225
7.2 Probability Density Functions 226
7.3 Brownian Motion 232
7.4 Ito Process 233
7.5 Poisson Process 243
8 Modeling Hybrids : Risk Neutrality 251
8.1 Introduction 251
8.2 Closed Form Solution 255
8.3 Tree-based methods 264
8.4 Finite Diverence Technique 289
8.5 Monte Carlo 290
9 Modeling Hybrids: Advanced Issues 299
9.1 Tail Risk in Hybrids 299
9.2 Jump-Divusion 301
9.3 Correlation 323
9.4 Structural Models 337
9.5 Conclusion 340
10 Modeling Hybrids : Handling Credit 343
10.1 Credit Spread 343
10.2 Default Intensity 348
10.3 Credit Default Swaps 350
10.4 Credit Triangle 365
10.5 Stochastic Credit 370
11 Constant Elasticity of Variance (CEV) 373
11.1 From Black-Scholes to CEV 373
11.2 Historical Parameter Estimation 378
11.3 Valuation : Analytical Solution 383
11.4 Valuation : Trinomial Trees for CEV 386
11.5 Jump-Extended CEV Process 394
11.6 Case Study : Pricing Mandatories with CEV 398
11.7 Case Study : Pricing Convertibles with a Reset 400
11.8 Calibration of CEV 410
12 Pricing Contingent Debt 417
12.1 Introduction 417
12.2 Credit Derivatives Method 418
12.3 Equity Derivatives Method 425
12.4 Coupon Deferral 439
12.5 Using Lattice Models 445
12.6 Linking Credit to Equity 447
12.7 CoCos with Upside : CoCoCo 455
12.8 Adding Stochastic Credit 460
12.9 Avoiding Death Spirals 467
12.10Appendix : Pricing Contingent Debt on a Trinomial Tree 470
13 Multi-Factor Models for Hybrids 479
13.1 Introduction 479
13.2 Early Exercise 481
13.3 American Monte Carlo 486
13.4 Multi-Factor Models 501
13.5 Conclusion 511
management at Jabre Capital Partners, a Geneva-based hedge fund. He
earned an extensive knowledge of derivatives pricing, hedging and
trading while working for KBC Financial Products in London, where
he was managing director of the equity derivatives desk. He also
ran his own market neutral statistical arbitrage hedge fund (EQM
Europe) after founding Erasmus capital in 2004. Prior to this
financial career, Jan served ten years in the Belgian Army as an
Officer. With Wim Schoutens he co-authored the Handbook of
Convertible Bonds published by Wiley.
Cynthia Van Hulle (Leuven, Belgium) is a full professor
of Finance at the Department of Accounting, Finance and Insurance
of the Faculty of Economics and Business at the Catholic University
of Leuven. Over the last 20 years she has acquired extensive
practical experience through her board memberships in the financial
sector and organization of in-company training programs. She has
published considerably in scientific journals a.o. Journal of
Banking and Finance, Journal of Finance, Journal of
Corporate Finance, European Financial Management,
Journal of Business Research, Journal of Business,
Finance and Accounting, Small Business Economics. She
also held the Francqui-chair and is co-author of several books in
corporate finance.
Wim Schoutens (Leuven, Belgium) is a research professor
in financial engineering at the Department of Mathematics at the
Catholic University of Leuven, Belgium. He has extensive practical
experience of model implementation and is well known for his
consulting work to the banking industry and other institutions. In
particular, he is an independent expert advisor to the European
Commission (DG-COMP) on impaired assets and asset relief measures
and has assessed in that position more than EUR 1 trillion of
assets; in particular he was one of the main expert advisors for
the stress test on the Spanish banks and the related bailouts. Wim
is also the author of several books including Contingent
Convertibles (CoCos): Structure and Pricing, the first book
ever on Contingent Capital and CoCo bonds (written together with
Jan De Spiegeleer). He is Managing Editor of the International
Journal of Theoretical and Applied Finance and Associate Editor of
Mathematical Finance, Quantitative Finance and Review of
Derivatives Research. Finally, he is member of the Belgium CPI
commission and independent director of the Board of Assénagon
Asset Management S.A.
