Valuation and analysis of zero-coupon contingent capital bonds (Q2342734)

This paper analyzes a zero-coupon contingent capital bond (CCB), which is a bond that converts to equity when the issuing firm experiences financial distress. Contingent capital is becoming increasingly important in the aftermath of the 2008 financial crisis. This paper develops a new approach to valuation of CCBs in the structural framework, focusing on the loss imposed on CCB investors at conversion. Specifically, it is important to set the terms of conversion such that seniority is respected and furthermore that equity investors are not rewarded for poor performance. This paper finds that the range of acceptable conversion prices/losses is relatively narrow, yielding important implications for structuring CCBs in practice.