What is a Debt Exchangeable for Common Stock?
Debt exchangeable for common stock (DECS) is a debt instrument that provides the holder with coupon payments in addition to an embedded short put option and a long call on the issuing company's stock. The primary convertible security is generally a listed structured product.
Understanding Debt Exchangeable for Common Stocks (DECS)
Debt exchangeable for common stock (DECS) instruments provide the holder with the right to convert the security into the underlying company's common stock. Preferred redeemable increased dividend equity securities (PRIDES) are one example of debt exchangeable for common stock and are synthetic securities consisting of a forward contract to purchase the issuer's underlying security and an interest-bearing deposit for a specific price. Interest payments are made at regular intervals, and conversion into the underlying security is mandatory at maturity. PRIDES were first introduced by Merrill Lynch & Co.
Securities designated as debt exchangeable for common stock is one more financial product that falls under the general classification of convertible securities or 'convertibles.' Convertibles are corporate securities (generally preferred stock or bonds) that are exchangeable for a set number of another form (usually common stock) at a pre-stated price. Investors are attracted to convertibles for their hybrid features: One part debt, with a semi-secure income stream, coupons; and a second feature offering growth, from equity's capital gains.
Convertibles are structured products that banks and other entities package to meet the demands of various types of investors. At times, a certain form of security is preferred, say debt, but investors' appetites are not as strong without the added equity-like features. To make a security more marketable, convertibility is one more feature that can increase the demand for certain types of securities.
Using Debt Exchangeable for Common Stock
A good example of where debt exchangeable for common stock might be used is for a company that is promising but young. Without a lengthy financial record, this company may not be able to secure conventional debt financing, particularly at a reasonable coupon rate. To cut interest costs and make the debt offering more attractive (marketable), this security can be packaged with an added option to convert the debt into common stock. Now, with the added potential of capital gains, investors might take a closer look while demanding a smaller coupon than a straight (option-free) bond.