CoCo bonds with extension risk : a building block approach
Jan De Spiegeleer (KU Leuven and Jabre Capital Partners, Switzerland)
Joint work with Wim Schoutens

Thursday June 5, 16:30-17:00 | session 9.2 | Hybrids | room CD

Contingent convertibles (CoCo bonds) have seen an issuance of up to \$70 bn (Dec 2013) and have attracted a lot of interest from hedge funds, institutional investors and retail investors. While the Basel III regulation is being rolled out and implemented into national law, banks are increasingly reinforcing their balance sheet with this particular asset class. In the new regulatory framework, contingent capital can either be considered as Tier 2 or as additional Tier 1 (AT1) capital. The latter category has a perpetual nature and has several embedded call dates. Contradictory to the callable hybrids bonds issued before the 2008 financial crisis, the AT1 category does not contain a coupon step up. For this particular reason, extension risk will play a more prominent role in CoCo bonds with an issuer call. This exposes the investor to negative price convexity for interest rate or credit spread changes. The valuation of extension risk for CoCo bonds has been modeled this paper.

American Put Under Stochastic Rates
Alexey Polishchuk (Bloomberg, USA)

Thursday June 5, 17:00-17:30 | session 9.2 | Hybrids | room CD

In this short note we demonstrate that in a wide class of Equity-Interest rate hybrid models the price of an American put decreases when the interest rate volatility is increased. Specifically we consider models where the equity volatility is local in the spot price and the spot-rate correlation is non-negative. It is imperative that we stay within the calibrated set of models and that for any choice of the interest rate volatility the model is re-calibrated to match the vanillas. As a corollary we deduce that the maximum price of an American put within the specified set of models is achieved when the interest rate volatility goes to zero and the underlying model reduces to the local volatility model of Dupire. The result holds for the Bermudan option as well.

Embedded Currency Exchange Options in Roll-over Loans
Uwe Wystup (University of Antwerp, Belgium)
Joint work with Andreas Weber

Thursday June 5, 17:30-18:00 | session 9.2 | Hybrids | room CD

In ship and aircraft financing long term roll-over loans are often equipped with the right to change the currency every quarter at spot. The loan taker then pays LIBOR of the respective currency plus a pre-determined constant sales margin. If the capital outstanding exceeds 105\% calculated in the original currency, the amortization is required to the level of 105\% of the original currency. By clever currency management the loan taker can amortize the loan faster and terminate the loan early. Essentially the loan taker owns a series of options on the cross currency basis spread with unknown notional amounts. We determine the key drivers of risk, an approach to valuation and hedging, taking into consideration the regulatory constraints of a required long term funding. We present a closed-form approximation to the pricing problem and illustrate its stability.