HOFIS 23 - Preferred Stocks Flashcards
1
Q
Compare and contrast the features of preferred stock with those of equity and debt on the following:
- Dividends
- Seniority and Balance sheet classification
- Ratings
A
- pays cash dividends on regular basis (cash flows normally fixed by contract)
- Claim is senior to that of common stocks, but junior to that of debt
- has debt ratings, just like corporate bonds
2
Q
Describe three types of preferred stock
A
- Fixed-Rate: pays a fixed dividend rate
-
Adjustable-Rate (ARPS): dividend rate is reset quarterly based on a predetrmined spread from the highest of three points on the Treasury yield curve
- e.g., 83% of the highest of: 3-month U.S. CMT rate, 10-year U.S. CMT rate, and 30-year U.S. CMT rate
- Protects against yield curve increasing
-
Auction-Rate and Remarketed: dividend rate is reset periodically through a Dutch auction procedure or through a remarketing agent
- Unlike APRS, it reflects current market conditions
3
Q
What issue of Adjustable-rate preferred stocks, does Auction-rate preferred stocks overcome?
A
Addresses the issue of ARPS trading below par-value when the issuer’s credit risk declines but the dividend-rate formula remains unchanged.
4
Q
Describe advantages of investing in preferred stock
A
- Offer higher yields (on average) than bonds or common stocks
- Diversification benefits due to low correlation w/ stocks and bonds
-
Tax advantage for qualified corporations:
- can have 70% of dividend payments be exempt from federal income tax
- not individual investors
5
Q
Describe disadvantages/risks of investing in preferred stock
A
- Limited potential for price appreciation
- most of total returns come from dividends
- Higher default risk from a missed dividend payment
- failure to make dividends cannot force bunkruptcy
- Some missed dividends are accrued, others cannot be recovered
- Some are callable, exposing the investor to reinvestment risk
- Less liquid than common stocks
