Preferred Stocks

Similarity and difference between preferred stock and common stock

Preferred stock and common stock are both ownership and an equity security

The difference is preferred stock acts as fixed-income unlike common stock due to dividend income, since all companies pay cash dividends on preferred stock unlike common

What is par value

Par value is the face value (the retail price of a stock not the resale)

It never changes its set and fixed to the initial price even if the market prices change

Assume par value is $100 unless told otherwise for questions

What is a coupon

A fixed dividend rate

What is a yield

Is the rate of return and income producing security provides

Difference between dividend rate and yield

Dividend rate is based on the unchanging par value but yield is based on the changing market price

How to find dividend rate

Dividend annual income / par

How to find yield rate

Dividend annual income / market price

When do you trade a discount

yield > dividend rate

When do you trade at par

yield = dividend rate

When do you trade at premium

yield < dividend rate

Is preferred stock negotiable

Yes

What is the driving factors of a preferred stock price

Interest rate changes

What happens if interest rates are low for too long

The fed will increase the rates

What are bonds

They are debt securities, investors loaning to issuers and paid interest over the bonds life

Connection between bonds and preferred stock

They trade on the same market so they compete with each other

Ex: Bond interest rate is 7% and a preferred stock is 3% you will pick the bond

What happens when interest rates rise

Preferred stock loses its value since its not as attractive as a security with a higher interest rate

What happens when interest rates lower

Preferred stock again its value since its higher than the interest rate now

Connection between interest rates fluctuation vs fixed income

Interest rates up = market price down

Interest rates down = market price up

Are dividends an obligation

No they aren’t the BOD approve dividends but they aren’t guaranteed, in fact companies facing financial issues can suspend dividend payments

Why wouldn’t issuers skip paying dividends

It shows that the company is incompetence making it hard to sell more shares in the future

What does it mean to be a cumulative preferred stockholder

Company must make up for past skipped dividends to preferred stockholders before making payments to common stockholders

Desirable meaning its offered in primary market with lowered dividends rates, also high demand in secondary market meaning higher prices and lower yield

What does it mean to be a straight preferred stockholder

Company isn’t required to make up past skipped dividends, just need to pay current dividends before paying common stockholders

Less desirable must be offered with higher dividend rates, low demand in the secondary market meaning lower prices and higher yield

What does it mean to be participating preferred stockholder

Receive more dividends if the company had a good year

Ex: Paid 12% dividend if the normal was 5%

Participating stock is more desirable to investors, offered in primary market with lower dividend rates

Also in demand in secondary market resulting in higher prices and lower yields

What is a callable preferred stockholder

Can be taken back by the issuer by paying an stockholder a specific amount (Par Value)

Favorable for issuers not holders

Not desirable so must be offered with higher dividend rates in the primary market and in the secondary market its’t in high demand meaning a lower price and higher yield

What does it mean to be redeemed

When an issuer takes back outstanding securities from investors in returns for payments of some form

When do you refinance

When interest rates are lower than what you currently have

What does it mean to refinance

Ex: You have a loan at 5% the rate now dropped to 3%. The 3% loan is more favorable for you so you take out an loan at 3% to pay back the previous one at 5% and now your loan is at 3%

What is the reinvestment risk

When reinvested funds obtain an investment with a lower rate of return

What is a call premium

Amount above the par value an issuer may obligate itself to pay holders when calling shares back

What is a call protection

The time before the issuer can exercise the call feature

Who does a call favor

The issuer and not the holder

What is a convertible share

Preferred shares that can be exchanged for a specific amount of common shares of the same issuer

What is an arbitrage opportunity

Buying and selling the same investment or security to make an instant profit

What is the conversion ratio

Determines how many common shares received when converting preferred shares

Benefits of preferred stock

Dividend income, fixed income

Corporate liquidation priority

1) unpaid wages

2) unpaid taxes

3) secured creditors

4) unsecured creditors

5) junior unsecured creditors

6) preferred stockholders

7) common stockholders

What are the characteristics of a preferred stock typical investor

Seeks income as a primary benefit

Accepts moderate risk in return for higher income

Long-term investor

What is a pro-rate

Right to receive dividends since they don’t have pre-emptive rights