Hybrid securities

Hybrid securities have a more special nature than just plain bonds. They hold often additional convertibility or redemption rights and result in different payoff structure. In many cases they are used to sweeten the deal for investors concerning young companies or companies in distress.

Convertibles

Convertibles are bonds which entitle bondholders to convert his loan into equity at a certain price agreed today at a certain date or period in the future. Investors holding convertibles can thus have a higher return when converting their bonds into equity when the company is performing really well.

Reverse convertibles

Reverse convertibles entitle the issuer of the bond to convert devoted bond money into equity at a certain price agreed today at a certain date or period in the future. This type of bond is of course much more risky for bondholders, as a result the offered interest rate on this product will typically be higher than on regular bonds.

Contingent convertibles

Continent convertibles, also knows as COCOs, are a type of reversed convertibles. They are a new kind of securitiy issued specifically by banks as a result of the new Basel III regulation. These securities are converted into equity contingent on the issuer falling short of the minimum capital threshold imposed by bank regulation.

Callable bonds

Callable bonds are regular bonds accompanied by option. The option allows companies to buy back their issued bonds for a certain period in the future. It could for example be interesting that a company buys back outstanding bonds after interest rates have declined a lot. As a result company profits go up since they can refinance them more cheaply. Because bondholders face the risk on early redemption, typically these bonds also offer a higher return.

Putable bonds

Putable bonds are also regular bonds accompanied by an option. The option now entitles bondholders selling their bonds to the company. This holds that companies are forced buying the offered bonds back when called in by bondholders. This could for example happen after sharp interest rate increases. Bondholders can then claim their money back and reinvest at a higher rate.

Summary

Hybrid securities change the payoff structure of bonds, making these bonds more attractive to either the investor or the issuer. In many cases, hybrid securities are used as a deal sweetener.

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