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Hybrid Step Up Bond

Hybrid Step Up Bond. Rocco Letterelli Marco Ticciati Muhammad Naeem. Definition. Three year Hybrid step up bond Pays a fixed coupon of 5% in the first year I n the second year there would be two cases

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Hybrid Step Up Bond

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  1. Hybrid Step Up Bond Rocco Letterelli Marco Ticciati Muhammad Naeem

  2. Definition Three year Hybrid step up bond • Pays a fixed coupon of 5% in the first year In the second year there would be two cases • At the time 1 if S1 >=S0 then the bank has a right to repay capital + premium OR • To Transform the bond in 2 year regular bond with a coupon of 7%

  3. Definition cont. • If at time 1 S1<S0, then bond doesn’t change its copon and will expire at time 3. • Charactristics • Fixed coupon (bond) • If stock has a good performance the owner has a benefit in terms of premium • higher coupon

  4. Benefits for the bank This kind of hybrid instrument, fill the gap left behind by the sum of supplementary capital to meet 100% core capital. They can be put forward in the limits of 15% of tier 1. Cost of capital with respect to the use of shares Interests expenditure are deductible like the common bonds LOWER WACC Less debt on balance sheet HIGHER RATING Neither debt nor equity small change of D/E ratio

  5. Benefits for the bank • t could be an alternative of the issuance of shares: • No diluted shares among shareholders • Less conflicts among shareholders • Less decrease of ROE and P/e ratio then in case of capital charge • Higher seniority than shares • Less cost of funding with respect to shares • No right to vote in the board of director

  6. Beneftis for the bank Banks can “surf” the trend of its income level It can give the money back when it can Because of good economic results or can can the money back for liquidity problems.. “results are good enough today but they could not be so good tomorrow and viceversa…”

  7. Costs for the bank Higher coupon in case of S1>S0 Bankneeds to monitor the underlying Hedgingproblem: to hedge this position the bankhas to find a counterparty in OTC market (for instancebuying a binary call)

  8. Potentialinvestors • Investors with a ‘medium’ riskprofile: theywant a fixed cash flow buttheywant to benefit if the stock bankhas a good performance. • Noticethatthis bond isriskierthan a regular bond because in case of default the owner of an hybrid bond isliquidatedafterbondholders and beforeshareholders • Furthermore the bankhas the right to repay the debtin advanceand the investorshave a benefit formthat in terms of return

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