1.3 Preferred Stock
Preferred stock is an equity security with bond-like characteristics. It pays a fixed dividend, has senior claims to common stock in liquidation, but generally carries no voting rights.
Key FINRA Exam Takeaways
- Preferred stock has fixed dividend payments, typically quoted as a % of $100 par value.
- Behaves like a fixed-income security: trades inversely with prevailing interest rates.
- Cumulative preferred requires payment of all dividends in arrears before common dividends.
- Callable preferred gives the issuer the right to repurchase shares at a stated call price, usually when interest rates fall.
- Convertible preferred allows conversion to common shares at a specified conversion ratio.
Preferred Stock Types
Straight (Non-cumulative): missed dividends are lost forever. Cumulative: missed dividends accumulate in arrears and must be satisfied prior to any common dividend. Participating: can receive additional dividends beyond stated rate if common dividends exceed targets. Callable: issuer can retire shares at predetermined premium. Convertible: can convert into common shares based on conversion price.
Interest Rate Sensitivity
Because preferred dividends are fixed, preferred stock prices fluctuate inversely with interest rates. When interest rates rise, preferred stock prices fall. When interest rates drop, preferred stock prices rise.
| Preferred Type | Key Feature | Benefit to Investor | Trade-Off |
|---|---|---|---|
| Straight / Non-Cumulative | Stated dividend only | Higher initial yield | Missed dividends never paid |
| Cumulative | Dividends in arrears accumulate | Protection of missed payouts | Slightly lower stated yield |
| Participating | Bonus dividend if earnings exceed target | Inflation protection | Lower fixed baseline rate |
| Convertible | Convertible to common stock | Capital appreciation potential | Lowest dividend yield |
| Callable | Issuer can redeem at stated call price | High dividend rate to compensate | Call risk when rates fall |
An investor holds 100 shares of 6% cumulative preferred stock ($100 par). The company skipped dividend payments for the past two years. In the current year, the company wishes to pay a dividend to common shareholders. What total amount must be paid to this preferred shareholder first?