Question

Describe the characteristics of hybrids of debt and equity funds like preference shares and convertible notes.

Answer 1

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 & Preferance Shares

Features of preference shares:

Preference shares are equity instruments that also have debt characteristics, such as a fixed dividend. This fixed dividend is cumulative, which means that even if the company is not able to pay the dividend in certain years, the dividend payments are deferred and roll up.

While preference shares may be redeemableor convertible (into common stock/ordinary shares) they do not have voting rights.

preference shares have a fixed dividend they generally do not share in the potential profit growth of the company and resemble a debt instrument rather than a share.

the dividends have to be paid out of profits that have borne tax, in contrast to interest payment on debt which is tax deductible

preference shares are considered as equity and have the advantage that they do not contribute to the gearing of the issuer.

Features of Convertible Bonds:

convertible bond is a regular bond that can be converted into ordinary shares of the company issuing the bond.

Convertible bonds pay interest like ordinary bonds but in addition, give the holder the option of converting the bond into a specified number of the bond issuer’s shares at a specific future date or dates. Exactly how many shares the bond can be converted into is stated by the conversion ratio, which typically assumes a premium on the share price at the time of the issue

the convertible bond is strongly influenced by fluctuations of the underlying price of the share into which it can be converted

The price of the bond will then be affected by changes in the underlying share price as well as interest rates.