19.3: Preferred Shares Flashcards
What are preferred shares and what are their key features?
Preferred shares are a type of equity that often provide fixed dividends and have priority over common shares for dividend payments.
Although dividends are not legally obligated until declared, preferred shares are generally considered lower risk, and their payments are virtually assured, appealing to investors seeking favorable tax treatment.
How are interest income and dividend income taxed differently in Canada, and why does this matter for preferred shares?
Interest income is taxed at regular income rates, while dividend income benefits from a tax credit, reducing the effective tax rate. This makes preferred shares attractive to investors seeking lower taxation on income compared to interest-bearing securities.
What are the three types of preferred shares mentioned in Table 19.3, and how do they differ?
The three types of preferred shares are:
- Straight Preferreds: Provide fixed dividend yields with no special redemption features.
- Retractable Preferreds: Allow the issuer or investor to redeem at specific prices on set dates, offering more flexibility.
- Floating Rate Preferred Shares: Have variable dividend rates tied to benchmark interest rates, adjusting with market conditions.
Compare the after-tax yield for individual investors at the top tax rate for Straight Preferreds and Retractable Preferreds.
The after-tax yield for individual investors at the top tax rate is 2.08% for Straight Preferreds and 2.02% for Retractable Preferreds, indicating slightly better after-tax returns for Straight Preferreds.
Why might an investor choose Floating Rate Preferred Shares over other types?
An investor might choose Floating Rate Preferred Shares to benefit from rising interest rates, as the dividend yield adjusts with market conditions, potentially offering higher income compared to fixed-rate preferred shares.
What does the term “after-tax spread yield” refer to in the context of preferred shares?
The “after-tax spread yield” refers to the yield on preferred shares after accounting for the effects of taxation, comparing it to the yield on equivalent government bonds, providing insight into the tax efficiency of the investment.
How does the dividend yield of Retractable Preferreds compare to that of Floating Rate Preferred Shares, and what might this indicate for investors?
The dividend yield of Retractable Preferreds is 3.80%, while Floating Rate Preferred Shares have a yield of 3.63%. Retractable Preferreds offer a slightly higher fixed yield, which may be more attractive to investors seeking stable income.
What is a straight preferred share?
A straight preferred share is a preferred share that has no maturity date and pays a fixed dividend at regular intervals, usually quarterly.
It is considered perpetual and is typically valued for its consistent income stream.
Why do straight preferred shares often have a higher yield than government bonds?
Straight preferred shares often have higher yields because they carry more risk than government bonds.
This includes equity risk and default risk since they are issued by corporations rather than the government, which generally has lower credit risk.
What is the tax value of money in the context of preferred shares?
The tax value of money refers to the advantage of income being taxed at preferential rates, such as dividends, making them more valuable than income taxed at ordinary rates like interest income. Preferred dividends often have favorable tax treatment, enhancing their appeal to investors.
What is a retractable preferred share?
A retractable preferred share is a type of preferred share that gives the investor the right to sell it back to the issuer at a specified price and date, effectively creating an early maturity date. This feature adds flexibility and potentially reduces risk.
Describe floating rate preferred shares and their benefit.
Floating rate preferred shares have a long maturity date but adjust their dividend yield at regular intervals, such as every three or six months, based on current market interest rates.
This feature allows them to offer yields that stay in line with market conditions, providing protection against rising interest rates.
What is a cumulative provision in preferred shares?
A cumulative provision stipulates that no dividends can be paid on common shares until preferred share dividends, both current and any in arrears, are paid in full.
This provision protects preferred shareholders by ensuring they receive dividends before any are paid to common shareholders.
Why are preferred shares considered hybrid securities?
Preferred shares are considered hybrid securities because they possess characteristics of both debt and equity.
They offer fixed dividends like bonds (debt) but are part of the equity structure of a company and usually do not confer voting rights.
How do preferred shares differ from bonds in terms of risk and return?
Preferred shares differ from bonds in that they are more susceptible to default risk, as they lack legal obligations for payment beyond declared dividends.
However, they generally offer higher yields than bonds to compensate for this risk, making them attractive to income-focused investors.
