Contingent convertible bonds (CoCo bonds)

Contingent convertible bonds (CoCo bonds) are convertibles that convert, or become convertible, is a specified event occurs, rather than being simply convertible at the option of the bond holder.

A typical CoCo bond is a bond that is automatically converted to equity if the issuer needs money: for example if the issuer is a bank the condition may be that it will convert to equity if the issuer's tier one capital falls below a limit. The automatic conversion will then re-capitalise the bank.

However, there are other types of CoCo. Some companies have issued bonds that only became convertible if the share price exceed a certain price (higher than the strike price). There are many more possibilities.

A CoCo always contains an embedded option, as it is a convertible. The second example above is more complex as the embedded option is a knock-in.

At the time of writing (November 2009), the issue of bank CoCo bonds in order to provide extra tier one capital in times of stress is expected to become widespread.

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