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.

Copyright Graeme Pietersz © 2005-2020