A hybrid instrument is called as a hybrid, due to its nature to inculcate the characteristics of more than one financial instrument i.e. Debt as well as Equity. Few of the various types of hybrid securities are convertibles bonds, capital notes and convertible preference shares. The investment features and the returns on these securities will depend upon various factors called as the “trigger events” – these triggers are namely- a loss of earnings to the entity which may lead to a deferral in the interest payments to the bondholders. Apart from this, the change in capital levels and the need to infuse the equity as well as the revision of tax laws and regulations which may provide the company an option to repay the bond early or later than expected could very well impact the investment characteristics of these instruments. The triggers are out of the control of the entity and are also very difficult to predict at the same time.
The returns which are expected by the holders of these hybrids are deeply impacted by the various risks and exposures existing in the financial markets. The few of which are briefed below:
- Market price volatility- it is the risk that the price of the listed hybrid instrument may fall below the acquisition price which had been paid by the investor. This can happen on account of the dismal operating and financial performance of the company. Moreover, a change in the market interest rates, as well as the fluctuation in the stock prices of the company, also impacts the price of listed hybrid securities.
- Liquidity risks – it is the risk that the hybrid instruments would not be available to be traded freely even though, they can be listed on the exchanges. Lack of liquidity impacts the possibility of frequent buying and selling in these securities. Hence, if one needs to immediately buy or sell these instruments, then he won’t be able to do that and may have to accept a lower price due to the lack of liquidity.
- Subordinate ranking: In case a liquidation of the corporation takes place, then the holder of these hybrid securities would be repaid and compensated much after the payments have been made to the various secured creditors. The reason behind such type of treatment given to the holders of these instruments is the fact that the Hybrid instruments are unsecured in nature and has got no charge over the assets of the company.
The investors must always take into consideration the creditworthiness of the corporation which is issuing the instrument and should also review the credit ratings which are been assigned by the renowned Credit rating agencies like S&P, Fitch, Moody, etc.
Hence an investor should make sure that he understands each and every aspect of hybrids before investing. Hence it is advised that the prospective investors must consult their financial advisors who can cater to their queries and provide the righteous advice when it comes to investing in these Hybrid Securities.
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