1. Comphrensive Passage :

Directions: Read the passage and answer the questions that follow:

During the financial crisis, Western governments poured hundreds of billions of dollars into their banks to avert collapse. The search for ways to avoid future bail-outs started before the turmoil ended. One of the niftiest proposals was the “contingent convertible” (coco) bond, which turns into equity when the ratio of a bank’s equity to risk-weighted assets falls below a predetermined danger point (since set at a minimum of 5.125% for cocos, although it can be up to around 7%). The ambition was grand. As the Squam Lake Group, composed of mostly American academics, put it in 2009, the automatic conversion of cocos would “transform an undercapitalised or insolvent bank into a well-capitalised bank at no cost to taxpayers”.

At first, regulators were keen. In 2010 Mervyn King, then the governor of the Bank of England, said he wanted contingent capital to be a “major part of the liability structure of the banking system”. Swiss regulators, too, pushed for coco issuance. The hybrid nature of cocos seemed a way to satisfy both regulators, who wanted banks to have bigger safety buffers, and bankers, who were reluctant to issue new shares because of the high cost of capital. The hope was that investors, too, might see the appeal of an asset that offered a higher yield than bank bonds but lower risk than bank shares.

Nine years after the first cocos were issued by Lloyds Banking Group in Britain, they have not fulfilled this promise. To be sure, they are now an established asset class, with around dollar 155bn of issuance in 2017 in Dollars, Euros and Pounds. But this is a fraction of more than dollar 1trn in bank debt issued that year. Cocos are issued by only around 50 banks in a dozen countries mostly in Europe. Although cocos are held by the world’s largest asset managers, including BlackRock and PIMCO, few specialise in them. Exceptions include niche funds run by Algebris Investment and Old Mutual Global Investors.

The main reason is that, despite early enthusiasm, regulators did not throw their weight behind cocos. In 2011, the Financial Stability Board, a global grouping of regulators, decided that they would not count towards the capital “surcharge” the biggest banks would be required to hold. Only equity would do. Rules on “total loss absorption capacity” finalised in 2015 require banks to have liabilities that can take a haircut or be wiped out if they are liquidated or restructured. But a wide range of liabilities, from shares to subordinated and even senior debt, is included. Cocos became part of a spectrum of at-risk liabilities, rather than a neat, catch-all solution.

The result is that cocos are a specialised investment proposition. They still offer fairly high yields—currently 5.3% for dollar cocos and 3% for those in euros, according to indices compiled by Credit Suisse, a bank. And they offer a premium over junior debt. They have appealing technical characteristics, too. Unlike bonds with a fixed maturity, they are perpetual, but redeemable after five years. If not redeemed, their coupon resets with reference to the mid-swap rate, a widely used rate related to interbank lending rates. That offers some protection against inflation. In 2016 investor jitters caused a spike in coco yields. But since then, nerves have calmed and spreads have narrowed.

2.
As per passage, what is meant by coco?

Coco refers to convertible bonds which can be converted from debt to equity after a certain number of years. Coco refers to a special type of bond which gets converted to debt when the debt-to-equity ratio of the bank falls below a certain level. Coco is used to refer to a situation where in the government forces a company to liquidate some of its shares so as to pay back its debt. None of the above

Hint Answer

3.
As per Squam Lake Group, what was biggest benefit of coco bonds?
I. It would keep costs to manage customer accounts to a bare minimum.
II. It was an off-balance sheet item and would not increase liability of banks.
III. It would help in capitalizing undercapitalized banks without any extra costs.

Only II Only III Only I and II Only II and III

Hint Answer

4.
As per passage, why would investors want to invest in coco bonds?
I. As cocos could play a major part in helping banks become safer.
II. As y wanted banks to have bigger safety buffer.
III. As y were reluctant to invest in equity shares of banks
IV. As cocos offered better yields than normal bank bonds with lesser risk.

Only IV Only I Only I, III and IV Only II, III and IV

Hint Answer

5.
Refer to- Nine years after first cocos were issued by Lloyds Banking Group in Britain, y have not fulfilled this promise. What is meant by author in line above?
I. Cocos are not a reliable asset class.
II. Cocos form only a tiny fraction of total bank debt issued.
III. Cocos do not seem to have made a big difference in banking system.

Only I Only III Only II and III Only I and II

Hint Answer

6.
As per passage, why were cocos not popular despite early enthusiasm?
I. Due to danger emanating from m to financial stability across Worlds Central Banks.
II. Due to lack of support from financial regulators.
III. They are too complicated to understand for retail investors.

Only III Only II Only I and II Only II and III

Hint Answer

7.
As per last paragraph, which of following is/are some features of coco bonds?
I. They protect against inflation to a certain extent.
II. They are perpetual in nature and do not have a fixed maturity period.
III. They offer fairly high yields which also includes a premium over junior forms of debt.

Only II Only III Only I and II All of the above

Hint Answer

8.
Which of following is/are true as per passage?
I. The first cocos were issued by Lloyds Banking Group in Britain.
II. The Financial Stability Board decided not to include cocos in capital banks would be required to hold.
IIIl. For investors already exposed to distressed banks, it generally makes sense eir to buy equity to recapitalise bank, or to lend to it in form of safer senior debt.

Only II Only III Only I and II Only I and III

Hint Answer

9.
Which of following is/are antonyms of word "jitters"?

Anxiety Anger Storm Calm

Hint Answer

10.
Which of following is/are synonyms of word "spectrum"?

Alcove Colors Gamut Effect

Hint Answer

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