U.S. Appetite For 'CoCo' Bonds Could Be Tested Soon--Bankers

http://online.wsj.com/article/BT-CO-20110215-712432.html

• "Many are pinning their hopes on a type of security called a contingent-convertible bond, or a 'CoCo', which converts from debt to equity when certain bank metrics, such as capital reserves or share price, fall below certain levels. The reduction in debt and increase in equity delivers a shot in the arm to the financial institutions' balance sheets."
• "While buyers are paid well for investing in CoCos--one batch of CoCos averaging 10 years to maturity currently yields around 10%, a full percentage point over comparable junk debt--the jury is out on how investors may respond when CoCos come to market."
• CoCos resemble hybrid securities because they convert from a bond-like instrument to an equity-like instrument, essentially recapitalizing the firm and staving off the sort of government bailout seen in the last crisis. Yet they differ from traditional hybrids because the conversion is mandatory, not at the option of the issuer.
• The trigger depends on the borrower's creditworthiness, as determined by a measure of financial cushioning called core Tier-1 capital--the strongest capital on a firm's balance sheet. Once CoCos convert into equity, investors would start to lose their principal and could be wiped out entirely before holders of subordinated and senior unsecured debt absorb any losses.
• A key consideration for investors is where that conversion trigger is set. The lower it is, the more attractive a CoCo is to a buyer because the issuer is more likely to be on its last legs when conversion occurs.

*Really* Long Term Bonds

Low interest rates have made "long-term bonds" attractive. Coca-Cola and Disney have previously issued 100 year bonds. But, that is nothing:

From A Study of Corporation Security by Arthur Stone Dewing:

The extreme longevity of a bond was presumed to have been reached when the west Shore Railroad placed on its lines a mortgage due in the year 2361. This is exceeded, however, by the farcical date of maturity of the Elmira and Williamsport 5% Income Bond of [the year] 2862

This Investopedia Article explains the merits of long-term bonds

Sam Rosenfeld: Life Settlement an Emerging Asset Class

Sam Rosenfeld, Managing Director of Longevity Mortality Strategies, has written a Wharton white paper on life settlements:

• "Life settlements do not arise from radical new concepts. Grounded in the same financial
  modeling as life insurance and annuities, their value is in creating a secondary market for
  life insurance policies where there was none."
• "The fundamental offering provided by life settlements is that they provide greater cash settlements for policies than the life insurers themselves, when the policyholder needs as much value as possible from their asset."
• These instruments are creating the need for better longevity models (better models for predicting longevity / mortality); this has value for individuals, their financial planners, etc.
• Synthetics and indices are emerging
• "It is a safe prediction that by the end of 2012, the key elements of portfolio diversification for sophisticated investors will be equities, bonds, commodities, real estate and longevity."

For a list of other life settlement funds, check out: http://www.rollscritique.com/insurance-linked-securities

What are the Drivers of Security Design

William Silber studied 38 financial products/processes introduced between 1970 and 1982 and concluded that the primary drivers of financial innovation are: inflation (especially high interest rates due to inflation), volatility of interest rates, technology, legislation, and internationalism.

Merton Miller (best-known as the Nobel-Prize winning co-author of the Modigliani-Miller Theorem concluded that the primary drivers were regulation and taxation; tax and regulation are "the major impulses to successful innovation."¹ Miller described financial innovations as "seeds beneath the snow, waiting for some change in the environment to bring them about."²

There are a basic set of features of a financial product - "ingredients" which can be mixed and matched "bundled and unbundled" to create new products:

"At its basic level, the financial instrument is a contract written on paper and potentially all possible financial contracts can be written without any technological barrier (Desai and Low, 1987, p. 115). In this sense, financial innovations are not new goods. They are implicitly always there, but in zero supply (Greenbaum and Heywood, 1973). …. Dufey and Giddy (1981) argue that financial innovation largely consists in the development of new ways of bundling the basic services. While the bundling and unbundling exhibits an infinite variety, the basic products themselves have remained largely unchanged. As Niehans (1983, p. 538) puts it, 'Except for electronic technology, if an experienced banker from medieval Venice or Geneva came to life again, he could understand the operations of a modern bank in a matter of days.³"

Other factors include issuers desire to reduce information and agency costs when raising capital.

More info available here:

Security Design Reading List, Part I

• "Evolution of Security Design" http://papers.ssrn.com/sol3/papers.cfm?abstract_id=511044
• "Security Design in Initial Public Offerings "http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1008411
• A study of corporation securities : their nature and uses in finance / by Arthur Stone Dewing; Dewing, Arthur
  

Other Implications of Baby Boomer Aging: Toys

A lot of people have draw the conclusion:

• Baby Boomers are aging -->
• There will be more old people -->
• Time to invest in healthcare, health services, and other services to satisfy he elderly

Another way to think about this is

• Baby Boomers had few children (Echo Boomers) -->
  
• Echo Boomers are having fewer children -->
  
• Investment in companies targeted towards children is less attractive (potentially shortable)

The companies that come to mind (Toys R Us, Nickelodeon, etc.) are either non-public or part of a larger company

Also, I would not necessarily advocate shorting Toys R Us - b/c it could very well grow despite industry headwinds (e.g., by picking up market share, via M&A, etc.). What may be interesting is shorting a hypothetical index of children-related companies.

Groupon CEO Interview

The Story Of Groupon: From Failure To An Industry-Changing, Profit Machine – with Andrew Mason

Interview w/ Groupon CEO