Preference Equity Redemption Cumulative Stock (PERCS)
By AKHILESH GANTI Updated September 30, 2021
Fact checked by SUZANNE KVILHAUG
What Is Preference Equity Redemption Cumulative Stock?
Preference equity redemption cumulative stock (PERCS) is an equity derivative that is classified as a hybrid security and automatically converts to equity at its pre-determined maturity date.
Understanding Preference Equity Redemption Cumulative Stock (PERCS)
Preference equity redemption cumulative stock (PERCS) is a convertible preferred stock with an enhanced dividend that is limited in term and participation. PERCS shares can be converted for shares of common stock in the underlying company at maturity. If the underlying common shares are trading below the PERCS strike price, they will be exchanged at a rate of 1:1; but if the underlying common shares are trading above the PERCS strike price, common shares are exchanged only up to the value of the strike price.
PERCS​=​m​i​n​(​Stock Price,PERCS Capped Price)
PERCS are essentially a form of a covered call option structure and are popular in an environment of declining yields because of the enhanced dividend. Upside profits are limited in order to produce a higher yield. PERCS can typically be redeemed before the maturity date, but at a premium to the cap price. Typically, if a holder of a PERCS does not redeem the shares within the mandated time horizon—usually a three- to five-year period—the shares are automatically converted to common stock shares and the dividends revert to those ordinary dividends that would be paid on that common stock.
PERCS falls under the umbrella of a non-traditional convertible security known as mandatory convertibles.
Mandatory convertibles are securities that have their own unique set of risk and reward characteristics, but they all share similar basic features. These include an upside potential that is typically less than that of the underlying common stock, due to the fact that convertible buyers must pay a premium for the privilege of converting their shares, and higher than market (enhanced) dividend rates.
There are three main characteristics of a mandatory convertible security, and these are true for PERCS as well:
They must have a mandatory conversion to the underlying stock.
They must have a dividend yield that is higher than that of the underlying stock.
Holder is entitled to capital appreciation, but it will be limited when compared to the appreciation potential of the underlying stock.
Other common mandatory convertibles are:
PERCS Example
If you own 10 PERCS on XYZ company with a strike price of $50, at maturity the following two outcomes could happen:
If, at maturity, the underlying asset was trading at $40, you would receive a total of 10 common shares, worth $40 each.
If, at maturity, the underlying asset was trading at $100, you would receive shares up to the total value of the PERCS strike price, which, in this case, would be five shares worth $100 each. The total value of the shares ($500) exchanged will equal the original strike price of $50 x 10 shares.
At the same time, say the dividend paid on common shares of XYZ is $1.00 per year. The PERCS shares might pay a dividend of $1.20 per year to their holders.
Related Terms
Dividend Enhanced Convertible Stock (DECS)
Dividend Enhanced Convertible Stock (DECS) is a preferred stock that provides holders with premium dividends. more
Preferred Equity Redemption Stock (PERC)
Preferred stock with special provisions limiting the value of its convertible shares and the mandatory redemption value at maturity. more
Mandatory Convertible
A mandatory convertible is a type of convertible bond that has a required conversion or redemption feature. Either on or before a contractual conversion date, the holder must convert the mandatory convertible into the underlying common stock.more
What Is a Preferred Stock?
Preferred stock refers to a class of ownership that has a higher claim on assets and earnings than common stock has. more
Preferred Redeemable Increased Dividend Equity Security (PRIDES) Definition
PRIDES are securities with a forward contract to purchase an underlying security and an interest-bearing deposit for a specific price. more
How Contingent Convertibles (CoCos) Work and the Risks
Contingent convertibles (CoCos) are similar to traditional convertible bonds in that there is a strike price, which is the cost of the stock when the bond converts into stock. more
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