Hybrid securities have characteristics of both debt and equity. They include convertibles and preference shares.
Convertibles are like debt securities with a conversion feature. Generally, they have the right to be paid a defined income stream and to be repaid the face value at a specified future date. Additionally, the holder has the right to convert the note into ordinary shares in the company at specified times. The manner in which the conversion to equity is calculated can vary. They include:
- Convertible notes: Generally pay a fixed coupon rate and can be converted into ordinary shares at a particular date or period of time in the future.
- Convertible securities: Generally have both debt and equity characteristics and convert into a dollar amount of the ordinary shares of a company at a future date at a set dollar amount or at a discount to the ordinary share price at that time.
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Preference shares pay income in the form of dividends, which may or may not be franked. The dividend rate may be fixed at the time of issue, or may float in line with market interest rates.
Preference shares usually have a conversion feature, signifying that at some point they may be converted into ordinary shares in the company. There may also be an option to repay the face value in cash. They include:
- Reset preference shares: Typically pay a fixed rate where the coupon is set for a defined term. At the end of the defined term, the securities are remarketed where they are either redeemed or a new fixed coupon rate is set. They are typically perpetual in nature.
- Step-up preference shares: Securities that have both debt and equity characteristics. These securities typically pay a floating rate coupon and have a call date after a set period. If these securities are not called at the first call date then the coupon ‘steps-up’; to a higher rate to compensate investors for non-redemption. They are typically perpetual in nature.
- Stepped-up preference shares: Securities that have both debt and equity characteristics that have already passed the call/step-up date and pay an additional amount over and above the original coupon. They are typically perpetual in nature although the issuer has the option to redeem the securities on any future coupon payment date.
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