Question
You want to estimate the cost of a firm's hybrid security.
The security was issued three years ago at $40/security. The price is currently $42/security. It pays a semiannual dividend of $2.00/security.
The company has the one-time option to pay a super dividend of $45/security in 5 years, which would cause the securities to expire (essentially, a buyback option).
Your research indicates that the company will exercise this option with a probability of 60%. What is the annualized cost of this firm's hybrid security capital?