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Hybrid Security – The Most Preferred and Popular Financial Instrument


Hybrid Security

What are Securities?

Securities are a financial instrument used by companies to raise capital.

In the corporate world, there are 3 major types of securities that can be categorically defined. They are differentiated based on their function and mode of operation.

– Equity Securities

– Debt securities

– Derivative securities

With Equity securities, the investors attain ownership in the companies. The most common type of these instruments is the stocks of a company.

With debt securities, the company can borrow from the public to raise its capital. Bond is the most common instrument used as debt security.

Derivative security depends on another underlying instrument and derives its value based on the other instrument. A contract is one of the examples of derivative security.

What are Hybrid Securities?

Another security that does not fit into any of these 3 categories. This is called Hybrid security. A hybrid security is a combination of more than one type of financial instruments. A stock and a bond together is an example of a hybrid security.

Hybrid Securities are often referred to as ‘hybrids’. They can be bought or sold either in the exchange or through a brokerage. A hybrid security is relatively a new concept yet is very popular due to its advantages.

Advantages of Hybrid Security

– Hybrid securities provide a high yield since the rate of return is higher than most senior debts.

– They are less volatile because the distribution of market returns is pre-determined and much regular.

– They have a diverse nature. As they are not bound to any specific category of securities, the overall risk involved is diversified, and thus guarantees attractive returns.

Disadvantages of Hybrid Security

– The only disadvantage of hybrid securities is its complexity. It is more complicated than investing in equity or bond security.

Types of Hybrid Securities

There are many different types of hybrid securities. The following are the most widely used.

1. Convertible Bond:  These bonds come with the power to get it converted to stocks of the same company.

2. Preferred Shares: These are also called preference stocks. In case of bankruptcy, the company pays off these shares first, before they pay the common shares.

3. Mezzanine Financing: This is a type of hybrid security where a lender gives a loan to a company and later can assume ownership by acquiring shares in case of default by the company.

4. Toggle Notes: This is a kind of security where the company has an option to defer payments of bonds in exchange for a higher rate of interest. This mainly occurs when the company is undergoing a short-term cash-flow crisis.

5. Warrants: This type of security allows, but not compels, the investors to buy or sell their shares on or before a particular date for a specific amount. Life of warrants is usually 10-15 years.

Each type of hybrid security has a unique risk involved and at the same time also has reward characteristics. Many other new types of hybrid securities are being introduced all the time in an attempt to meet the needs of sophisticated investors.

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