Preferred Stock

Lesson

Preferred stock is a type of equity security representing company ownership. Preferred stock has characteristics of both common stock and bonds, and it is considered a hybrid security. Preferred stockholders have a higher claim on a company's assets and earnings than common stockholders, but they do not have voting rights. The main features of preferred stock include dividend payments, liquidation preference, and conversion rights.

Practice Question #1

Which of the following is a characteristic of preferred stock?

A) Voting rights

B) Liquidation preference

C) Fixed maturity date

D) Unsecured debt

Select an option above to see an explanation here.

A) Voting rights are typically associated with common stock. B) Liquidation preference is a characteristic of preferred stock, prioritizing preferred stockholders over common stockholders in the event of liquidation. C) A fixed maturity date is associated with bonds. D) Unsecured debt is associated with debentures.

Terms

Preferred Stock:: A type of equity security representing ownership in a company with priority over common stockholders regarding dividends and liquidation.
Conversion Rights:: The right of a preferred stockholder to convert their preferred shares into common shares.
Cumulative Dividends:: A feature of some preferred stocks that requires any missed dividend payments to be paid to preferred stockholders before any dividends are paid to common stockholders.
Non-Cumulative Dividends:: A feature of some preferred stocks that do not require missed dividend payments to be paid to preferred stockholders.
Callable Preferred Stock:: A type of preferred stock that allows the issuer to redeem the shares at a predetermined price after a specified date.
Participating Preferred Stock:: A type of preferred stock that allows the holder to receive additional dividends if the company's profits exceed a certain level.
Convertible Preferred Stock:: A type of preferred stock that can be converted into common stock at the holder's option.
Voting Rights:: The right of a shareholder to vote on matters affecting the company, such as electing directors and approving mergers.

Practice Question #2

What is the main difference between cumulative and non-cumulative preferred stock dividends?

A) Cumulative dividends are paid annually, while non-cumulative dividends are paid quarterly.

B) Cumulative dividends require missed payments to be paid before common stock dividends, while non-cumulative dividends do not.

C) Cumulative dividends are paid only if the company's profits exceed a certain level, while non-cumulative dividends are paid regardless of profits.

D) Cumulative dividends can be converted into common stock, while non-cumulative dividends cannot.

Select an option above to see an explanation here.

A) The frequency of dividend payments is not the main difference between cumulative and non-cumulative dividends. B) Cumulative dividends require any missed dividend payments to be paid to preferred stockholders before any dividends are paid to common stockholders. In contrast, non-cumulative dividends do not have this requirement. C) This description applies to participating preferred stock, not cumulative or non-cumulative dividends. D) This description applies to convertible preferred stock, not cumulative or non-cumulative dividends.

Do Not Confuse With

Common Stock:: A type of equity security that represents ownership in a company and usually comes with voting rights.
Bonds:: Debt securities issued by companies or governments that pay interest and have a fixed maturity date.
Debentures:: Unsecured debt securities issued by a company, backed only by its creditworthiness and reputation.

Practice Question #3

Which type of preferred stock allows the issuer to redeem the shares at a predetermined price after a specified date?

A) Callable preferred stock

B) Participating preferred stock

C) Convertible preferred stock

D) Cumulative preferred stock

Select an option above to see an explanation here.

A) Callable preferred stock allows the issuer to redeem the shares at a predetermined price after a specified date. B) Participating preferred stock allows the holder to receive additional dividends if the company's profits exceed a certain level. C) Convertible preferred stock can be converted into common stock at the holder's option. D) Cumulative preferred stock requires any missed dividend payments to be paid to preferred stockholders before dividends are paid to common stockholders.

Historical Example

In the 2008 financial crisis, many banks issued preferred stock to raise capital and improve their balance sheets. Some of these preferred stocks had high dividend rates, which attracted investors seeking income. However, as the crisis deepened, some banks were forced to cut or suspend their dividend payments, causing the value of their preferred stocks to decline significantly.

Practice Question #4

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Example Series 65 Example Practice Question

Real-World Example

A company issues preferred stock with a 6% dividend rate and a liquidation preference of $25 per share. If the company goes bankrupt and its assets are liquidated, preferred stockholders will receive $25 per share before any payments are made to common stockholders. Additionally, preferred stockholders will receive a 6% annual dividend, which must be paid before any dividends are paid to common stockholders.