Hybrid Securities in Basic Terms, Hybrid Securities

Hybrid Securities

In basic terms, hybrid securities have features that easily distinguish them from other kinds of securities. In their most basic form, they have characteristics of both equity and debt. For this reason, they cannot be classified as either debt or equity. The three hybrid securities I concern myself with below are convertibles, warrants, and preferred stock.

Preferred Stock

In the words of Carey and Essayyad (2001), "preferred stock is a security which pays fixed dividends" (p.89). When seeking to raise capital for growth or expansion, companies can issue two kinds of stock, i.e. common and preferred stock. As is the case with common stock, investors who buy preferred stock provide the company with money in exchange for the corporation's shares. For this reason, preferred stock can be likened to equity. It is however important to note that preferred stock could in some instances be likened to bonds. This is particularly the case given that they pay a regular dividend. Unlike common stock which does not guarantee investors a regular stream of income, preferred stock could be seen as a fixed income-security. In the event of liquidation, preferred stockholders have a claim on the assets of an entity before common stockholders (but after holders of corporate bonds) and for this reason, many view preferred stock as being safer than common stock (Carey and Essayyad, 2001). Companies could use preferred stock as a way of regulating control of the business. This is particularly the case given that holders of this kind of stock lack voting rights.

Warrants

In basic terms, "a warrant is a security that allows the holder to subscribe to another newly issues security (share, bond, or even another warrant) during a given period, in a proportion and at a price fixed in advance" (Vernimmen et al. 2011, p.461). Should the price of the security rise above the said fixed price, then the holder of the warranty can purchase the same security at the price fixed in advance and offer it for sale at the prevailing market price. In most instances, companies offer warrants alongside other securities and for this reason, Carey and Essayyad (2001) point out that they are viewed as "sweeteners" in corporate financing. This is more so the case given that they "enhance the marketability of the accompanying low-interest fixed income securities" (Carey and Essayyad 2001, p.91). A warrant's lifetime is in most cases measured in years.

Convertibles