security

What It Is

A fixed income security is an investment that pays regular income in the form of a coupon payment, interest payment or preferred dividend.

How It Works

Fixed income securities provide periodic income payments at an interest or dividend rate known in advance by the holder. The most common fixed-income securities include Treasury bonds, corporate bonds, certificates of deposit (CDs) and preferred stock.

Holders of Treasury bonds and CDs receive a fixed interest rate based on a par value over a specific period of time. Holders of preferred stock are entitled to a periodic fixed dividend specified by the issuing company for as long as they own the shares.

To illustrate, suppose an investor owns a Treasury bond with a par value of $1,000 and an annual yield of 6%. This investor is guaranteed a payment of $60 each year for the life of the bond. Similarly, an investor who holds preferred stock in Company XYZ might be promised a quarterly dividend payment of $5 per share, which he can dependably receive for as long as he holds the shares.

Why It Matters

Fixed income securities are an excellent choice for risk-averse investors seeking a stable source of income payments at predictable intervals. Fixed income investors and prospective investors should understand that the relatively low risk of fixed income securities generally translates into relatively lower returns.

Source: Investing Answers

What It Is

A hybrid security is a security that has characteristics of one or more asset classes.

How It Works

For example, a convertible bond is a hybrid security because it is a bond that allows the holder to exchange the bond for other securities (usually the issuer's stock). Mechanically, convertible bonds let the holder use the par value of the bond to purchase other securities from the issuer at a specified price.

For example, consider a Company XYZ bond with a $1,000 par value that is convertible into Company XYZ common stock. If the conversion price of the common shares is $25, then the bondholder can convert each of his or her bonds into 40 Company XYZ shares ($1,000 / $25 = 40). In this scenario, we would say that the conversion ratio is 40:1. Many hybrid securities are callable, meaning that under certain circumstances the issuer can redeem them before they mature.

Why It Matters

Hybrid securities require their investors to conduct extra analyses. For instance, the conversion price is not the only aspect of a convertible bond to analyze. Like other bonds, convertible bonds usually offer a coupon, and their prices are based on prevailing market rates and the credit quality of the issuer. Because conversion would mean losing those interest payments, investors also compare the coupon payment of the bond to the dividend yield of the common shares when they're thinking of converting.

Another thing to consider when investing in hybrid securities is their trading behavior. For instance, the more a convertible bond is "in the money," that is, the more the market value of the shares exceeds the conversion price, the more the bond itself trades like a stock. The bond's price tends to rise as the stock price approaches the conversion price (similar to a call option). The more volatile the stock price when in this zone, the more volatile the bond price. Interestingly, this relationship allows convertible bondholders to participate in the company's stock price appreciation.

Source: Investing Answers