The Capital Markets

CHAPTER 15Preferred Stock

Sarah Swammy

Preferred stock is a hybrid security with features common to both stocks and bonds. These securities are attractive to investors because they offer periodic income (fixed or variable payments), competitive returns (yields), liquidity (traded on major exchanges) and portfolio diversification. Preferreds are generally issued by companies that have outstanding common stock and normally issued with a par value of $25, which may correlate to the issuer's current market price and dividend. The main difference between common and preferred stocks is the manner in which dividends are paid. Common stock holders receive dividends only at the discretion of the issuer, based on the issuer's earnings and payout ratio. Preferred shareholders are entitled to receive dividends at a predetermined rate (either fixed or variable) by agreement. This agreement is similar to a bond indenture, and sets forth the respective rights and obligations of the preferred buyer and corporate issuer, but unlike most bonds, preferred shares do not have the same form of a guarantee to pay and thus are subordinate to bondholders. The dividends must be paid to preferred shareholders in full before any dividends can be paid to holders of common stock. In other words, payment of the preferred dividends is senior to the payment of dividends to common stockholders. The dividend is paid to preferred stockholders at a set rate as a percentage of par.

In addition, preferred stock ...