What are Premium Adjustable Convertible Securities?
- Premium Adjustable Convertible Securities (PEACS) combine features of debt and equity.
- PEACS pay a coupon like other bonds, though they come with the option to convert the instrument into common stock at a set price.
- PEACS give investors access to interest and principal payments without sacrificing the chance to participate in the company's capital appreciation.
Premium Adjustable Convertible Securities (PEACS) are often described as hybrid securities because they combine features of debt and equity, converting to ordinary shares at a set date based on a predetermined ratio.
Hybrid securities generally pay a rate of return, which could be fixed or variable, for a certain predetermined period. However, they also contain characteristics of an equity investment, which means there is an increased element of risk, as well.
Convertible securities typically offer a guaranteed interest payment at a specified rate, along with a par value that is achieved at maturity. Unlike a standard bond, however, a convertible security offers the option for the holder to transform the debt into equities if they so choose.
Other types of hybrid securities include pay-in-kind toggle notes, which allow the issuing company to toggle the payment from interest rates to additional debt owing to the investor.
Pros and Cons of Premium Adjustable Convertible Security (PEACS)
If the conversion option is not exercised, the PEACS would continue to act like a normal coupon paying bond, and would provide the investor with accrued interest earnings through the maturity date. This payout is generally lower than what investors can expect with a standard coupon paying security, because the investor is sacrificing some potential guaranteed payout in exchange for the opportunity to switch to an equity investment structure if they decide to exercise that option.
Convertible securities such as PEACS allow investors to acquire a debt instrument with rights to interest and principal payments without sacrificing the chance to participate in the company's capital appreciation. When a company does well, investors can convert the debenture into stock that has a higher value. When a company is less successful, investors can retain the bond and receive interest and principal payments.
Convertible-bond mutual funds can provide a diversified investment in convertibles. These funds are meant to offer most of the upside potential of stocks while limiting downside risk.
Because of the unique structure of PEACS (and convertible securities in general), it is important for investors to educate themselves about how these financial instruments work. Less experienced investors should consult a financial advisor before making major investment decisions, including those that involve convertible securities.