As a consequence each of the mentioned types of bank capital represents its own risk class. Investors clearly have to be compensated to carry the additional risks compared with senior bank bonds. Figure 4.3 shows that on average the spread differentials between senior bonds and Lower Tier 2, Lower Tier 2 and Upper Tier 2, and Upper Tier 2 and Tier 1 tend to be roughly equal. But one should note that spread volatility also increases significantly when moving to more subordinated types of bank debt. Again, this can be explained by the Merton model. Since Tier 1 and Upper Tier 2 bonds are designed to absorb losses before holders of senior bonds and Lower Tier 2 suffer a loss, the strike price of their embedded short put option is closer at the money than that of senior and Lower Tier 2 bonds. Hence, in absolute terms the delta of the short put is higher, causing larger changes of the value of the option and consequently spreads, when fundamentals change.