There are 2 basic sources of capital in finance - namely equity and debt. Equity is the money of the owners of the business while debt is money that is borrowed. When a company earns money, it must pay interest on debt before it can pay a dividend which is the return on equity. In the event of a firm being wound up, debt would be paid first and whatever is left afterwards is given to the owners.

The choice to invest in either equity (also known as shares, ordinary shares and common stock) or debt is dependent on many factors including the nature of the return to the investor. Generally, equity is riskier than debt because debt is a contractual agreement that must be fulfilled while equity is not. The interest on debt must be paid while dividends carry no such obligation. However, equity is attractive because dividends are sometimes much higher than the interest paid on debt.

A hybrid security is a finance instrument that has features of both debt and equity. So it could be a share that is obliged to pay a dividend which is either a fixed amount or at fixed intervals. It could be a debt instrument that is entitled to a share of the profits after receiving the interest due. The 2 that come most immediately to mind are convertible bonds, and preferred shares.

The flexibility of hybrid securtities make them attractive to both firms and investors. However, their exotic nature means they are not as popular as their vanilla parents. Markets for them are also not as big.

Iron Noder 2020, 23/30

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