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"Hybrid" securities

Some investments have characteristics of both stocks and bonds. They're more complex, so they may not be right for everyone.

POINTS TO KNOW

  • Preferred stocks have a face value and pay interest, but they're traded on an exchange.
  • Exchange-traded notes have a maturity date, but their value fluctuates based on a specified stock index.
  • Convertible bonds can be changed into stocks if it's beneficial for the investor.
  • For most people, a portfolio of stocks and bonds provides plenty of diversification. Sophisticated investors may want to consider strategies that use hybrid investments.

Preferred stocks

Like bonds, preferred stocks (also called preferred securities) have a face value and pay income at specified intervals. They're also susceptible to interest rate risk (though less so than regular bonds).

However, as with common stocks, preferred stocks are traded on exchanges like the New York Stock Exchange. The values of preferred stocks will fluctuate with the market, although not to the same extent as common stocks.

Preferred stock owners have no ownership or voting rights. If a company issuing a preferred stock is in financial trouble, the holders of the preferred stocks will be paid after bondholders but before common stockholders. Thus, their risk is somewhere in between common stocks and bonds.

Exchange-traded notes

Exchange-traded notes (ETNs) also have characteristics of both stocks and bonds.

Like stocks, they're unsecured (meaning they're not backed by collateral). In addition, holders of ETNs will be paid behind bondholders and preferred stock holders. ETNs are traded on stock exchanges and their values are based on the performance of a specified market index.

Like bonds, however, ETNs have a maturity date (although they don't pay interest), at which time the holder will be paid the current principal amount.

Convertible bonds

Convertible bonds (also called convertible securities) are corporate bonds that can be converted into stocks if the buyer chooses. Because of this added flexibility, convertible bonds generally offer lower interest rates than similar nonconvertible corporate bonds.

The risk and potential return for convertible bonds is somewhere between common stocks and regular bonds.


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REFERENCE CONTENT

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Bond

A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.

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Face value

The amount that the holder of a bond will be paid by the issuer at maturity, which can differ from the bond's value on the open market.

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Income

The interest and dividends generated by an investment.

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Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Exchange

A marketplace in which investments are traded. The exchange ensures fair and orderly trading and publishes price information for securities trading on that exchange.

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Risk

Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.

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Index

An unmanaged group of securities whose overall performance is used as a benchmark. An index may be broad or focus on one sector or type of security.

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Maturity

The length of time between a bond's issue date and when its face value will be repaid.

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Interest

Income you can receive by investing in bonds or cash investments. The investment's interest rate is specified when it's issued.

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Returns

The profit you get from investing money. Over time, this profit is based mainly on the amount of risk associated with the investment. So, for example, less-risky investments like certificates of deposit (CDs) or savings accounts generally earn a low rate of return, and higher-risk investments like stocks generally earn a higher rate of return.