What is hybrid security?
A hybrid security is a single financial security that combines two or more different financial instruments. Hybrid securities, often referred to as “hybrids”, generally combine both debt and equity characteristics. The most common type of hybrid security is a convertible bond which has the characteristics of an ordinary bond but which is strongly influenced by the price movements of the shares in which it is convertible.
Understanding hybrid titles
Hybrid securities are bought and sold on the stock exchange or through a brokerage. Hybrids can give investors a fixed or floating rate of return and can pay returns in the form of interest or dividends. Some hybrids return their nominal value to the holder at maturity and some benefit from tax advantages. Hybrid securities can be viewed as a form of esoteric debt and can be difficult to sell due to their complexity.
Types of hybrid securities
In addition to convertible bonds, another popular type of hybrid security is convertible preferred shares, which pay dividends at a fixed or floating rate before dividends are paid on common shares, and can be exchanged for company shares under -jacente.
Rocker-in-kind notes are another type of hybrid security where the issuing company can switch the interest rate payment to the additional debt owed to the investor, which means the company owes more debt to the investor but don’t actually pay interest on it. at once. This deferral of interest allows the business to continue to make cash flow, but the most important principal payment may never happen if the cash situation is not resolved.
Each type of hybrid security has unique risk and reward features. Convertible bonds offer greater appreciation potential than ordinary bonds, but pay less interest than conventional bonds, while facing the risk that the underlying company may perform poorly. They may also not make coupon payments and may not be able to redeem the face value of the bond at maturity. Convertible securities offer higher income potential than ordinary securities but may still lose value if the underlying company underperforms. Other risks of hybrid securities include deferred interest payments, insolvency, market price volatility, early redemption and illiquidity.
Other new types of hybrid securities are constantly being introduced to meet the needs of sophisticated investors. Some of these titles are so complicated that it is difficult to define them as debt or equity.
In addition to being difficult to understand, another criticism of some hybrid securities is that they force the investor to take more risks than potential warrants. Hybrid securities are not sold to individual investors, but even institutional investors do not always understand the terms of the agreement they enter into when purchasing a hybrid security.