Hybrid security
Hybrid securities are a broad group of securities that combine the characteristics of the two broader groups of securities, debt and equity.
Hybrid securities pay a predictable rate of return or dividend until a certain date, at which point the holder has a number of options, including converting the securities into the underlying share.
Therefore, unlike with a share of stock, the holder enjoys a predetermined cash flow, and, unlike with a fixed interest security, the holder enjoys an option to convert the security to the underlying equity. Other common examples include convertible and converting preference shares.
A hybrid security is structured differently than fixed-interest securities. While the price of some securities behaves more like that of fixed-interest securities, others behave more like the underlying shares into which they may convert.
Examples
- A convertible bond is a bond that can be converted into common shares of the issuer. A convertible bond can be valued as a combination of a straight bond and an option to purchase the company's stock.
- A redeemable, or callable, preferred stock confers the issuer to repurchase the stock at a preset price after a specified date, converting it to treasury stock. Therefore, if interest rates decline, the company has the flexibility to redeem the stock and subsequently re-issue it at a lower rate, reducing its cost of capital.
- A PIK loan may carry a detachable warrant – the loan is the debt, while the warrant is the equity
Important terms
- Returns: Predictable dividend, often franked therefore possible tax advantage to the holder
- Capital price:
- Discount: A discount is usually offered to the share price at the time of conversion.
- Reset/resettable: At the reset date the terms of the security may change. The holder can elect to accept the new reset terms or convert into shares.
- Cumulative/non-cumulative This refers to the event of missed dividend payments.
- '''Redeemable/non-redeemable'''