Hybrid Investments A Cross Between Debt & Equity

Given the development and evolution of products in our capital market, there are now some hybrid investments that are part equity and part debt.

Loan Stocks
You may have heard of CULS, which are unsecured loan stocks. A loan stock is a security issued by a company for a loan made to it by investors. CULS combine certain advantages of bonds (which are loan securities) with the option of converting into ordinary shares, known as the conversion privilege. The bond characteristics of CULS are they pay investors a fixed rate of interest and the principal sum on maturity. The equity part of ICULS materialises when they are converted into shares where the investor can enjoy possibilities of capital appreciation.

CULS can be issued in the form of redeemable (RCULS) or irredeemable (ICULS) convertible unsecured loan stocks. If the loan stocks are irredeemable, the holder must convert the ICULS into shares on maturity (normally after four to five years) at a predetermined conversion ratio and conversion price. If redeemable, then on maturity the holder can either convert the RCULS into shares or redeem the RCULS from the issuing company at their par value.

Companies issue CULS because they make the bonds more saleable with the addition of a conversion privilege. CULS also lower the cost of borrowing money and may enable the company to raise equity indirectly on more favourable terms than through the issue of new shares. To the investor, CULS gives him a security that combines much of the safety and income certainty of a bond with the option to convert into common shares and benefit from any increase in share prices.

Preference shares
Preference shares are also a form of equity hybrid, which carry a prior right to a fixed dividend (ordinary shares do not have a right to a fixed dividend). This fixed dividend is usually expressed as a percentage of the share's nominal value, and is paid when sufficient profits are earned. Preference shares that also carry the right of any arrears of preference dividend which has not been paid, is known as cumulative preference shares. Preference shares that are not entitled to such arrears in dividends are called non-cumulative preference shares.