Hybrid securities

December 30, 2020 By Swapnil Suryawanshi

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 (fixed or floating) 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 (equity), the holder enjoys a predetermined (rather than residual) cash flow, and, unlike with a fixed interest security (debt), the holder enjoys an option to convert the security to the underlying equity. Other common examples include convertible and converting preference shares.

Hybrid Securities (Meaning, Types) | Top 4 Risk with Hybrid Securities

Examples :

  • convertible bond is a bond (i.e. a loan to the issuer) 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.
  • PIK loan may carry a detachable warrant (the right to purchase a certain number of shares of stock or bonds at a given price for a certain period of time) – the loan is the debt (Bond), while the warrant is the equity
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