Explanation:
CoCos (Contingent Convertible bonds) are debt instruments that automatically convert to equity or suffer a principal write-down when a specific trigger event occurs, such as the bank's capital falling below a certain regulatory threshold. They do not give the holder the option to convert (making A and B incorrect). CoCos are specifically designed to absorb losses on a going-concern basis and are typically classified as Additional Tier 1 (AT1) capital under Basel III, rendering C incorrect. Although CoCos are generally less expensive than equity (due to tax deductibility of interest), they allow the issuing bank to report a higher Return on Equity (ROE) until conversion because they do not dilute the equity base. Option D is the best answer by elimination, highlighting the ROE benefit before conversion.
Ultimate access to all questions.
A
CoCos give their holders the option to convert them into the equity of the issuing bank either before maturity or at maturity, depending on the type of CoCo.
B
CoCos give their holders the option to convert their medium- or long-term debt to short-term debt if certain interest rate conditions specified in the indenture are met.
C
CoCos may be included in Tier 2 capital but not in Tier 1 or Additional Tier 1 capital due to the risks they pose to the issuing bank and the difficulties in pricing them.
D
CoCos can be more expensive for banks to issue than equity, but they allow the issuing bank to report a higher return on equity until they are converted.
No comments yet.