Preferred Stock

Definition

Preferred stock is a type of equity security that gives shareholders a higher claim on assets and earnings than common stockholders. It typically pays fixed dividends, which must be paid out before any dividends are distributed to common stockholders, making it an attractive option for investors seeking stable income. Preferred stock also often comes with other features such as convertibility into common shares and callable options, which can enhance its value and appeal in financial analysis.

5 Must Know Facts For Your Next Test

1. Preferred stock usually comes with a fixed dividend rate, which can make it less volatile than common stock.
2. In the event of liquidation, preferred shareholders have priority over common shareholders in recovering their investments.
3. Some preferred stocks have features that allow them to be converted into common shares, giving investors the potential for capital appreciation.
4. Preferred stock does not usually carry voting rights, which means preferred shareholders do not have a say in corporate governance like common shareholders do.
5. The market price of preferred stock can fluctuate based on interest rates, as fixed dividends become more or less attractive relative to other investments.

Review Questions

• How does preferred stock differ from common stock in terms of dividend payments and shareholder rights?
  • Preferred stock differs from common stock primarily in dividend payments and shareholder rights. Preferred shareholders receive fixed dividends that must be paid before any dividends are issued to common stockholders. Additionally, preferred stock typically does not confer voting rights, which means preferred shareholders have no say in corporate decisions unlike common shareholders who can vote on matters such as board elections and company policies.
• Analyze the impact of interest rate changes on the market price of preferred stock.
  • Interest rate changes significantly impact the market price of preferred stock. When interest rates rise, newly issued securities may offer higher returns, making existing preferred stocks with lower fixed dividends less attractive. As a result, the prices of existing preferred stocks may decline to adjust to the new market conditions. Conversely, when interest rates fall, preferred stocks with fixed dividends become more appealing, potentially increasing their market prices as investors seek stable income sources.
• Evaluate the role of preferred stock in corporate financing strategies and its implications for shareholder value creation.
  • Preferred stock plays a strategic role in corporate financing by allowing companies to raise capital while minimizing dilution of common shares and preserving voting control for existing shareholders. By offering fixed dividends, companies can attract income-focused investors without incurring high costs associated with debt financing. This can enhance shareholder value creation by providing stable funding for growth initiatives while maintaining flexibility in financial management. The unique characteristics of preferred stock can also cater to diverse investor preferences, ultimately contributing to a more balanced capital structure.

Related terms

Common Stock: Common stock represents ownership in a company and provides voting rights, but it comes with lower claim on assets and dividends compared to preferred stock.

Dividends: Dividends are payments made by a corporation to its shareholders, typically derived from profits, with preferred stockholders receiving their dividends before common stockholders.

Convertible Securities: Convertible securities are financial instruments, like preferred stock, that can be converted into a different form of security, usually common stock, under certain conditions.