ch 2 preferred stock

preferred stock

represents ownership and is an equity security, but it behaves more like a fixed-income security

yield

is the rate of return an income-producing security provides. based on fluctuating market price

DR = dividend annual income / par

(never changes)

dividend rate formula

CY = dividend annual income / market price

(fluctuates based on marked price)

current yield formula

the cost of borrowing money

what is the implication of an interest rate

par value

• Also known as face value

• Typically $100 for preferred stock

  • Could also be $25 or $50

• Never fluctuates

• Dividend rate based on ___

yield

• Represents overall rate of return

• Based on market price and dividend rate

• Continually fluctuates

• Yield and market price are inverses

  • Low market price = high yield

  • High market price = low yield

discount

market price trading below par

premium

market price trading above par

market price goes down

what happens to market price when interest rates go up

market price goes up

what happens to market price when interest rates go down

• Fixed income market prices decline

what happens to fixed income market prices when interest rates are rising

fixed income market prices increase

what happens to fixed income market prices when interest rates are falling

feature

built-in characteristics that affect how the security works.

cumulative

• Issuer must eventually pay skipped dividends

• Beneficial feature for investors

• Associated with:

  • Higher market prices

  • Lower dividend rates

  • Lower yields

straight (non-cumulative)

• Issuer does not pay skipped payments

• Beneficial feature for the issuer

• Associated with:

  • Higher dividend rates

  • Lower market prices

  • Higher yields

participating

• Eligible to receive more than the stated dividend rate

• Issuers pay more in profitable years

• Beneficial feature for the investor

• Associated with:

  • Higher market prices

  • Lower dividend rates

  • Lower yields

call feature

• Allow issuers to end an investment by paying back a specified amount

• Typically exercised when interest rates fall (refinance)

• Beneficial feature for the issuer

• Associated with:

  • Higher dividend rates

  • Lower market prices

  • Higher yields

call protection

• Number of years before security can be called

call premium

• Amount above par required to call shares

convertable preferred stock

• Convertible into common stock of the same issuer

• Beneficial feature for investors

• Associated with:

  • Higher market prices

  • Lower dividend rates

  • Lower yields

conversion ratio

• Determines how many common shares received at conversion

• Set at issuance and stays fixed

inflation (purchasing power risk)

risk that preferred stock is exposed to compared to common stock