What's going on?

European bank stocks got hammered�again on Monday with many banks down more than 5%. Deutsche Bank, one of Europe�s largest banks, was down almost 10%. Some concern focused on an often ignored investment called �coco bonds��(full name = contingent convertible bonds).

What does this mean?

These coco bonds are relatively new products. They are sort of like a�bond, except with some very important differences. For one, banks can choose not to pay interest to coco owners (with normal bonds, such an action would be a sign of bankruptcy). A report on Monday suggested that Deutsche Bank might have to forgo paying interest on its cocos in 2017 as it might need to save its money for other purposes.

Also, owners of coco bonds can be forced to either have the amount they are owed reduced or be given stock in the bank rather than cash. That can only happen when the bank in question runs of out spare money (a.k.a. �capital�). So, since cocos do badly when the bank�s share price goes down, one way for coco owners to offset their exposure is by placing a �bet� that the bank�s stock will go down, i.e. the coco owner would lose money on the coco, but make money via their �bet� that the stock goes down. And those negative �bets� are, probably, contributing to the pressure on European banks.

Why should I care?

Bigger picture: Trouble with European banks is affecting European government bonds. Bonds of countries like Portugal, Spain and Italy are starting to sell off relative to German government bonds. Investors view such �peripheral� countries as riskier investments than Germany partly because if there are significant problems in the banking sector, those countries are presumed to be less able to afford to backstop their banks than Germany (yes, banks in those countries also have coco bonds). While the severity is not yet reminiscent of the European crisis of 2011/12, the fundamental problems arguably remain intact.

For you personally: Private banks have historically been large holders of cocos. Many wealthy individuals bought cocos because of the high interest they offered. They were viewed as safe investments partly because such well known banks were issuing them. But this selloff is a reminder that higher returns do not come without higher risk.