Hybrid securities quiz

Borrowing & credit iconTake this quiz to see how much you know about bank hybrids (capital notes, convertible preference shares and subordinated notes) and corporate hybrids (subordinated notes). This quiz is only about common features of different types of hybrids and not about individual products.

It will help you to read our hybrid securities webpages before you do this quiz.

There are ten questions. Select an answer to receive feedback. Your score is calculated at the end. 

Clock Estimated time: 5 mins

investing-companynoteWhat are hybrid securities?

  • A way for banks and companies to borrow money from investors in return for interest payments
  • Securities which combine some of the features of debt (fixed interest) and equity (shares)
  • Complex investments that even experienced investors struggle to understand
  • All of the above

That's right. Hybrid securities are used by banks and companies to borrow money from investors, but they have complex features and risks, and may not be suitable for you if you need steady returns or capital security.

Incorrect. The correct answer is "all of the above". Hybrid securities are used by banks and companies to borrow money from investors, but they have complex features and risks that even experienced investors struggle to understand.

investing-share-notesCan you compare term deposits, subordinated notes and capital notes, issued by a bank, just by looking at the interest rates?

  • Yes - they are all issued by the same bank, so you just need to compare the interest rates
  • No - they are different types of investments so just comparing the interest rates is not enough

That's right. Just because they are issued by the same bank doesn't mean they are similar products. Different products have different risks. The prospectus for bank hybrids (capital notes, convertible preference shares and subordinated notes) usually includes a table comparing that hybrid to other investments offered by the same bank, including term deposits, to help you compare these investments.

Incorrect. Different products have different risks. The prospectus for bank hybrids (capital notes, convertible preference shares and subordinated notes) usually includes a table comparing that hybrid to other investments offered by the same bank, including term deposits, to help you compare these investments.

investing-percentdiceAn investment newsletter compares the interest rate payable on subordinated notes issued by Company A to corporate bonds issued by Companies B and C. Is this a fair comparison?

  • Yes, as long as Companies A, B and C have the same sort of business
  • Yes, as long as the subordinated notes and the bonds all mature at the same time
  • No, because the terms of the subordinated notes will be different to those of the corporate bonds

That's right. The terms of the subordinated notes will be different from those of the corporate bonds. They may contain trigger events which can have a significant impact on how the subordinated notes behave and subordinated note holders generally rank behind bondholders if the company becomes insolvent.

Incorrect. The terms of the subordinated notes will be different from those of the corporate bonds. They may contain trigger events which can have a significant impact on how the subordinated notes behave and subordinated note holders generally rank behind bondholders if the company becomes insolvent.

investing-percentdice2If a subordinated note offers cumulative interest payments "paid quarterly in arrears, subject to deferral", this means:

  • Interest is guaranteed to be paid every 3 months
  • Interest should be paid every 3 months but may be deferred. Any missed payments are recorded and due to be paid at some future date
  • Interest may not always be paid and any missed payments are lost

That's right. Because the interest payments are cumulative, any missed payments are added to future payments, but you will still be temporarily out of pocket.

Incorrect. If interest payments are subject to deferral, it means they may not always be paid on schedule. Because they are cumulative, missed payments are added to future payments.

arrow-manIf a subordinated note is described as having "a first call date of 5 years, an interest step-up date of 25 years and a maturity of 60 years", when is the company required to return capital to investors?

  • 5 years
  • 25 years
  • 60 years

That's right. While the company has the option to repay investors after 5 years and must start paying a higher rate of interest after 25 years, they are not required to repay investors capital until the maturity date. Securities may be sold on a secondary market such as the ASX before this time, but only if there is a demand for that security.

Incorrect. While the company has the option to repay investors after 5 years and must start paying a higher rate of interest after 25 years, they are not required to repay investors capital until the maturity date. Securities may be sold on a secondary market such as the ASX before this time, but only if there is a demand for that security.

investing-twenty-dollar-faceCompanies that issue subordinated notes often have substantial senior debt which ranks ahead of subordinated notes. Before lending a company money, you should consider:

  • The amount of senior debt the company has and how much money it is looking to raise by issuing subordinated notes
  • Whether the company generates enough cash to make payments on both senior debt and subordinated notes, now and in the future
  • If there are limits on the company's ability to pay interest or repay principal to subordinated note investors while it has senior debt
  • All of the above

That's right. Corporate hybrids can be designed to support a company's senior debt, as senior lenders are repaid ahead of hybrid investors. It is important to read the prospectus and understand how much senior debt there is and what limits it places on the company.

The correct answer is "all of the above". Corporate hybrids can be designed to support a company's senior debt, as senior lenders are repaid ahead of hybrid investors. It is important to read the prospectus and understand how much senior debt there is, and what limits it places on the company.

investing-piechartHybrids issued by Company A are described as "subordinated notes" having "second ranking security". If you invest in these hybrids and Company A becomes insolvent:

  • You will be repaid your entire investment, because the hybrids are "secured"
  • You could lose some or all of your investment
  • You will get nothing back

That's right. Any amount of capital you will be repaid in an insolvency situation depends on the value of the assets that can be realised for repayment and the amount of senior debt that has to be repaid first..

Incorrect. You may only get some return of capital depending on the value of the assets that can be realised for repayment and the amount of senior debt that has to be repaid first.

hookBank hybrids are designed to be "loss absorbing". This means:

  • They have a margin of safety built in, so that even if there is a market downturn your investment is protected
  • You, not the bank, are at risk of suffering a loss. They are designed to protect the bank's depositors at the expense of hybrid investors.
  • Your investment will be safe as it is covered by the government guarantee on deposits

That's right. "Loss absorbing" means that if the bank experiences financial difficulty, your investment can be converted into bank shares, which may be worth less than your initial investment. It could even write them off completely, meaning you could lose all of your capital.

Incorrect. "Loss absorbing" means that if the bank experiences financial difficulty, your investment can be converted into bank shares, which may be worth less than your initial investment. It could even write them off completely, meaning you could lose all of your capital.

investing-graph-penA bank has both capital notes and subordinated notes on issue. Interest payments (which are called 'distributions' on the capital notes) are:

  • The same for both hybrids
  • Higher on the subordinated notes
  • Able to be deferred for up to 5 years
  • Payable at regular intervals on the subordinated notes, but discretionary on the capital notes

That's right. Interest payments on bank subordinated notes are payable at regular intervals, while distributions on capital notes are at the discretion of the bank.

Incorrect. Interest payments on bank subordinated notes are payable at regular intervals, while distributions on capital notes are at the discretion of the bank.

investing-calculatorIf you invest in a bank's capital notes which have a scheduled conversion date of 10 years, and a first call date of 6 years when will your capital be repaid?

  • After 10 years, either in cash or ordinary shares in the bank
  • After 6 years at the bank's discretion, if regulatory approval is obtained
  • At any time if there is a change to laws or regulatory requirements
  • Any of the above, or never

That's right. While capital notes have a scheduled conversion date, sometimes called a mandatory conversion date, they may not actually be converted or repaid on this date if the bank's share price has fallen significantly. They may also be repaid on other fixed dates if the bank obtains regulatory approval, or at any time if certain trigger events occur. Capital notes may also be sold on a secondary market such as the ASX, but only if there is a demand for that security.

Incorrect. While capital notes have a scheduled conversion date, sometimes called a mandatory conversion date, they may not actually be converted or repaid on this date if the bank's share price has fallen significantly. They may also be repaid on other fixed dates if the bank obtains regulatory approval, or at any time if certain trigger events occur. Capital notes may also be sold on a secondary market such as the ASX, but only if there is a demand for that security.

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Warning:

Hybrid securities are complex products. Even experienced investors will struggle to understand the risks involved in trading them. If you don't fully understand how they work you should not invest. The terms of each hybrid security are different. You should read the prospectus and make sure you fully understand the features and risks of any particular investment in hybrid securities before committing your money.

Read our hybrid securities page to find out more.

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Last updated: 26 Jul 2016