Corporations issue preferred stock to raise funds. Preferred stock differs from common stock in several important ways. A corporation’s preferred stock yields higher dividends than does its common stock and the company must pay all preferred dividends before paying any dividends on the common stock. A corporation can create multiple preferred stock issues, each with its own set of characteristics. The corporation's ability to redeem or retract preferred shares lets it control the life-span and long-term costs of its shares.
Corporations can forcibly redeem, or “call,” redeemable preferred shares. If the corporation calls your preferred shares, it sends you a redemption notice informing you that your shares are cancelled and replaced by a cash payment. The corporation’s offering prospectus for the preferred stock must clearly state whether the shares are redeemable, when they can first be called and at what price. The corporation’s ability to call preferred shares can be a disadvantage to shareholders if the call price paid for the shares is lower than the current market price of the preferred shares.
Preferred stock issued without a maturity date is called “perpetual,” whereas “retractable” preferred shares have a finite lifetime ending on a specified maturity date. On the maturity date, the corporation cancels the retractable preferred shares in return for a predetermined cash payment. Retractability is another feature that the corporation must specify in the stock’s prospectus. Retractable shares might also be redeemable before the maturity date. The stock prospectus may specify a “soft” retraction in which the corporation retains the right to pay for the retracted shares with common stock rather than cash. If the corporation pays for the retraction with common stock, it normally issues common shares worth 95 percent of the preferred stock’s value at current market prices.
Corporations usually issue preferred shares that have a fixed dividend. Like fixed-interest bonds, fixed-dividend preferred stock is subject to interest rates risk. If interest rates rise, investors bid down the prices of existing fixed-payment securities in favor of newer, higher-return issues. A floating preferred stock has an adjustable dividend that periodically realigns with prevailing interest rates. Such issues have stable prices compared to those of fixed-dividend issues. Floating-rate preferred shares are usually retractable.
Corporations often attach a “put option” to retractable preferred shares. This option gives the shareholder the right to put, or sell, the shares back to the corporation for a preset price. The put option places a minimum price floor under the preferred shares, an attractive feature to shareholders. Put options can also be embedded in perpetual preferred shares. Indeed, corporations can mix and match many different preferred share features. For example, in addition to the features already mentioned, “convertible” preferred shares can be converted into shares of common stock at the shareholder’s request.
- Stock Investing For Dummies; Paul Mladjenovic
- Investing In Preferred Stock: An Introduction For Modern Income Investors; Paul Josephs
- Preferred Stock Investing; Doug K. Le Du
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