DEFINITION of 'Exchangeable Security'

An exchangeable security is an equity-linked investment instrument that typically involves the issuance of a debt security that can be exchanged at a future date into common stock, or the cash equivalent in some cases. Importantly, it grants its holder the right to trade it for a specified number of shares of common stock of a firm other than the issuer of the exchangeable security.

Exchangeable securities differ from convertible securities in this sense, because they are exchangeable for shares of a different company, while convertible securities are redeemable for shares of the company that issued the convertible security. A certain date or the completion of a specified event at some point in the future that triggers the exchange for common stock is specified with each exchangeable security. They may be structured to be redeemed at the option of the issuer or the holder of the security. An exchangeable security that is automatically exchanged for the underlying common stock, and/or cash, is known as a mandatory exchangeable security.

BREAKING DOWN 'Exchangeable Security'

The holder of the exchangeable security receives a fixed coupon payment from the debt instrument that is typically notably higher than the dividend payment on the underlying common stock for which it can be redeemed. Exchangeable securities use prespecified formulas to determine the number of shares of common stock or cash equivalent that the holder will receive upon exchange. In these formulas, the holder of the exchangeable security is often subject to all of the downside and exposed to most but not all of the upside of holding the subject stock.

For example, assume an exchangeable security is issued for a stock currently trading at $100. The payout formula may be written such that if, at the time of the stated maturity date, the stock is trading at less than $50, the holder will get one share of stock; if it is trading between $100 and $125, the holder will get $100 worth of stock; and if it is trading at higher than $125, the holder will receive 2/3 of a share of stock. Exchangeable securities can be thought of as debt instruments with an embedded option with respect to the underlying common stock.

Usefulness of Exchangeable Securities

Exchangeable securities are sometimes issued by corporations that are involved in a takeover. The acquiring company may wish to purchase the target company, but may need funds to complete the transaction. In this case, the acquiring company can sell an exchangeable security. The exchangeable security would give its owner the right to a specified number of shares in the target company after a specified date. If the acquisition is successful, the exchangeable security can be traded for shares of the target company.

RELATED TERMS
  1. Exchange

    An exchange is a marketplace in which securities, commodities, ...
  2. Covered Security

    A covered security is a type of security that receives federal ...
  3. Stock Market

    The stock market consists of the exchanges or OTC markets in ...
  4. Investment Securities

    Investment securities are securities (tradable financial assets ...
  5. Marketable Securities

    Marketable securities are liquid financial instruments that can ...
  6. Bermuda Stock Exchange - BSX

    The Bermuda Stock Exchange (BSX) is the main exchange of Bermuda, ...
Related Articles
  1. Investing

    Stock Exchanges: A Global Tour

    Check out the history and inner workings of the world's six most well-known stock exchanges.
  2. Investing

    What's a Debt Security?

    A debt security is a financial instrument issued by a company (usually a publicly traded corporation) and sold to an investor.
  3. Insights

    The NYSE and Nasdaq: How They Work

    Learn some of the important differences in the way these exchanges operate and the securities that trade on them.
  4. Taxes

    How Does a Tax-Free Exchange Work?

    In regards to the sale of property, particularly in real estate, a 1031 exchange is increasingly being recognized for its tax benefits to investors of all levels.
  5. Insights

    The Birth of Stock Exchanges

    Learn about the evolution of stock exchanges, from the Venetian states to the British coffeehouses, and finally to the NYSE.
  6. Investing

    Bill of Exchange

    A bill of exchange is a document used in international trade to pay for goods or services. It is signed by the person promising to pay, and given to the person entitled to receive the money. ...
  7. Trading

    How to Calculate an Exchange Rate

    Struggling to get a grasp on exchange rates? Here's what you need to know.
  8. Trading

    6 factors that influence exchange rates

    Aside from interest rates and inflation, the exchange rate is one of the most important determinants of a country's level of economic health.
RELATED FAQS
  1. What are all of the securities markets in the U.S.A?

    Securities can be bought and sold via a number of exchanges in the US. Learn about the major and somewhat lesser-known U.S. ... Read Answer >>
  2. Move from an OTC to a major exchange

    In order to move a company from over-the-counter market to a major exchange, a number of conditions must be met to being ... Read Answer >>
  3. What are the rules behind the delisting of a stock?

    Find out the criteria for a company to remain listed on a stock exchange. Learn what actions would lead to a security being ... Read Answer >>
  4. Can stocks be traded on more than one exchange?

    A stock can trade on any exchange on which it is listed. A company can list its shares on more than one exchange, in a dual ... Read Answer >>
  5. How can I identify stocks that also trade as options?

    The easiest way to find out which stocks also trade as options is to visit exchange websites. Read Answer >>
Trading Center