Question

Explain how you dealt with securities that had debt and equity characteristics.

Answer 1

Answer-

The hybrid securities are financial instruments that have qualities of both debt and equity securities.

In general the hybrid securities are issued by a company to investors when the company’s financial condition becomes stressed.

The characterization of the hybrid as debt or equity is important because of the impact of issuance as debt can have on a company’s solvency however refering it as equity will be fine, however characterizing it as debt the net value of the company will decrease by the amount equal to the value of the securities and referred an apparently solvent company insolvent.

A typical hybrid security as debt is by cash flows through maturity similar to interest and setting a maturity date and expected return of amount borrowed.

When the same security is classified as equity then  it represents a residual interest in the assets of the firm with no covenants and the issuer retains the authority ofdistributing dividends.