In the investment world, organizations create many different types of debt to both help raise funds for projects and appeal to borrowers or investors that may be interested in these debt types. Common instruments include stock, which is not debt at all but equity, and bonds, which is a type of structured debt issued by organizations for investor purchase. But hybrid instruments tend to combine different aspects of other options into a new form of investment, which can have both advantages and disadvantages.
Definition
Hybrid debt is a type of investment instrument that has some qualities of debt and some qualities of equity, or can shift between the two based on investor decisions. Hybrid instruments are rare compared to full debt or full equity options, but they do occupy an important place in the investment process, especially for intelligent investors that want to balance out a portfolio. Preferred stock and convertible debt instruments are some of the available hybrid options.
Preferred Stock
Preferred stock is separate from common stock and shares some qualities with loan-like bonds. Common stock allows investors to own part of the company and gives them at least a fraction of voting rights, while preferred stock does not. Preferred stock pays investors through a set dividend amount, a clear payment structure that acts more like the terms of a bond than the rising and falling values of common stock. If a company fails and has money left over to pay stockholders, preferred stock is redeemed before common stock.
Convertible Instruments
Convertible instruments start out as one type of instrument but allow investors to change it to another. For instance, convertible bonds may give investors the option to eventually turn them into shares of stock in the same company. Convertible preferred stock can be changed into common stock. Companies that create convertible instruments tend to put strict limits on them, requiring them to reach a certain stock price or time frame before conversion.
Purpose
Hybrid debt instruments offer flexibility to investors. An investor can buy a convertible bond, wait for an opportune time, and change it into shares to make easy profit. Hybrid instruments that combine aspects of both equity and debt, like preferred stock, tend to be less risky in some ways and more useful if an investor wants to find a dependable company with a good dividend plan. The variety of hybrid options makes the investment market a more interesting and potentially profitable arena.
