Rocco Letterelli
Marco Ticciati
Muhammad Naeem
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%
 If at time 1 S1<S0, then bond doesn’t change its copon
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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
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
Neither debt nor equity
HIGHER RATING
small change of D/E ratio
 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
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…”
• Higher coupon in case of S1>S0
• Bank needs to monitor the underlying
• Hedging problem: to hedge this position the
bank has to find a counterparty in OTC market
(for instance buying a binary call)
 Investors with a ‘medium’ risk profile : they want a
fixed cash flow but they want to benefit if the stock
bank has a good performance.
 Notice that this bond is riskier than a regular bond
because in case of default the owner of an hybrid bond
is liquidated after bondholders and before
shareholders
 Furthermore the bank has the right to repay the debt
in advance and the investors have a benefit form that
in terms of return