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SIE - Achievable > Preferred Stock > Flashcards

Preferred Stock Flashcards

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1
Q

What entices investments into preferred stock?

A

Dividend income.

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2
Q

Which companies pay cash dividend on preferred stock?

A

ALL companies.

*only SOME companies pay cash dividends on common stock.

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3
Q

Is preferred stock volatile?

A

Yes, but not as much as the common stock market.

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4
Q

What are preferred stock prices most commonly influenced by?

A

Interest rate changes in the market.

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5
Q

What do “fixed income investments” do?

A

They make consistent, predictable payments to their investors.

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6
Q

Preferred stock characteristics (3)

A
  1. Form of equity ownership
  2. Market prices (influenced by interest rates and do not fluctuate as much as common stock prices)
  3. Considered a fixed income security
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7
Q

How often does preferred stock make cash dividend payments?

A

Typically, on a semi-annual basis (twice per year).

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8
Q

Who approves the dividend payment for preferred stock?

A

The BOD.

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9
Q

What is “par value” sometimes referred to as?

A

The “face value” of fixed income investments like preferred stocks and bonds.

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10
Q

True or false: when preferred stock is sold for the first time, it’s almost always sold at apr value.

A

True.

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11
Q

Why is par value important?

A

It determines the amount of dividends to be paid to investors.

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12
Q

Define “coupon”

A

A fixed dividend rate of preferred stock, which is based on par.

Ex. ExxonMobil sells a $100 par, 5% preferred stock. Shares sold at par ($100) and will pay $5 every year to their investors (5% of $100). Because preferred stock makes payments semi-annually, the investment will pay $2.50 per share every six months.

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13
Q

True or false, regardless of the market price of the preferred stock, it will always pay dividends based on par value.

A

True.

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14
Q

Does par value stay fix over the life of the preferred stock, or does it fluctuate?

A

It stays fixed; never fluctuates.

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15
Q

Are dividend payments REQUIRED to be paid?

A

Technically, no.

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16
Q

What does it mean if preferred stock is “cumulative”?

A

If it’s cumulative, the issuer is required to pay any sipped dividends to preferred stockholders at some point in the future.

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17
Q

What does it mean if preferred stock is “straight”?

A

If it’s straight, the issuer does not need to make up any skipped dividends, ever.

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18
Q

Why is preferred stock “preferred”?

A

It takes preference over common stock when it comes to dividends. In order for an issuer to make a dividend payment to common stockholders, it must make all required payments to preferred stockholders first.

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19
Q

Which type of preferred stock is more beneficial to investors if the issuer skips dividend payments?

A

Cumulative.

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20
Q

True or false: Cumulative preferred stock is desirable to investors and can be sold with lower dividend rates than straight preferred stock.

A

True.

**When an investment comes with an added benefit to the investor, the security is typically sold with lower rates of return (and vice versa).

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21
Q

Key points: cumulative preferred stock (3)

A
  1. Issuer must eventually pay skipped dividends;
  2. Beneficial feature for investors;
  3. Lower rates of return (vs. straight);
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22
Q

Key points: straight (non-cumulative) preferred stock (3)

A
  1. Issuer does not pay skipped payments;
  2. Beneficial feature for issuer;
  3. Higher rates of return (vs. cumulative).
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23
Q

What is the “Dividend Rate”?

A

Based on par; never changes

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24
Q

Dividend Rate formula:

A

DR = Annual Income / Par

So on a 5%, $100 par preferred stock, the DR is $5/$100 = 5%

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25
Q

What is “yield”?

A

Represents overall rate of return;

Based on market price and dividend rate;

Continually fluctuates;

Yield and market price are inverse

  • low market price=high yield
  • high market price=low yield
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26
Q

Current Yield Formula:

A

CY = annual income / market price

So, for a 5%, $100 par preferred stock purchased at $95, the CY = $5/$95 = 5.26%.

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27
Q

Does the current yield fluctuate based on market price?

A

Yes.

28
Q

An investor purchases a 5% $100 par preferred stock. What’s the current yield if purchased for $100?

A

Annual income / market price

$5/$100 = 5%

29
Q

The higher the price of the preferred stock, the lower the ______.

A

Yield.

30
Q

What is it called if a preferred stock is selling at a price below par value?

A

A “discount.”

31
Q

What is it called if a preferred stock is selling at a price above its par value?

A

A “premium.”

32
Q

Current yield is a quick and easy way of determining a customer’s overall _______.

A

Rate of return.

33
Q

What is the relationship of yield to dividend rate when stock is selling at a discount?

A

yield > dividend rate

34
Q

What is the relationship of yield to dividend rate when stock is selling at par?

A

yield = dividend rate

35
Q

What is the relationship of yield to dividend rate when stock is selling at a premium?

A

yield < dividend rate

36
Q

What determines the market price of a preferred stock?

A

Demand

37
Q

What is an interest rate?

A

The cost of borrowing money.

38
Q

What happens if interest rates are too low for too long?

A

Inflation tends to rise.

39
Q

What is the most significant influencer rates in the Untied States.

A

Federal Reserve

40
Q

What is the underlying force behind market demand?

A

Interest rates.

41
Q

Does preferred stock pay interest?

A

No. Interest relates to borrowed money.

42
Q

Is the market price for preferred stock influenced by interest rate changes?

A

Yes.

43
Q

How do investors make money off bonds?

A

When an investor purchases a bond from an issuer, they are paid interest over the life of the bond. Essentially, the investor is lending their money to the issuer in return for interest payments.

44
Q

True or false: when preferred shares are issued, they are typically sold at par with a dividend rate that reflects current interest rates.

A

True.

45
Q

What happens when the price of preferred stock is lowered?

A

The current yield increases.

46
Q

Capital Gain

A

Return received when selling an investment at a higher price than its original cost; making a gain on a sale.

47
Q

What happens when the price of preferred stock is increased?

A

The yield of the preferred stock falls.

48
Q

What does it mean if preferred stock is “participating”?

A

That it’s eligible for more dividends than the stated dividend rate.

In other words, if you owned a $100 par, 5% preferred stock, you would earn $5 per year, per share. If your preferred stock was participating, you could expect to be paid more than $5 per year if the company had a prosperous year.

49
Q

Is participating preferred stock beneficial to the stockholder?

A

Yes. Therefore, it can be sold for higher prices in the market.

50
Q

Key points for participating preferred stock

A

Eligible to receive more than stated dividend rate

Issuers pay more in profitable years

Beneficial feature for the investor

Lower rates of return (vs. non-participating shares)

Trades at higher prices and lower yields

51
Q

What does it mean if preferred stock is “convertible”?

A

It can be converted into common stock of the same issuer.

52
Q

Why is convertible preferred stock beneficial to the stockholder?

A

It provides two separate ways for the investor to make a return.

53
Q

Preferred stock is primarily utilized as a ________.

A

Fixed income investment, which typically pays semi-annual income to its investors.

54
Q

Which stock market offers more opportunity for capital gains – common or preferred?

A

Common.

55
Q

What is the conversion ratio?

A

It tells the preferred stockholder how many shares of common stock they receive if they convert their shares.

56
Q

When is the conversion ratio set?

A

When the preferred stock is originally issued and stays fixed.

57
Q

Does the issuer have to obtain voter approval to issue convertible preferred stock?

A

Yes.

58
Q

What does it mean when preferred stock is “callable”?

A

It can be destroyed by the issuer. A call feature allows the issuer to end an investment by making a par (face) value payment to s shareholders.

59
Q

What happens if the issuer calls your preferred stock?

A

The issuer will pay you the par value per share owned. After the preferred stock is called, the investment ends and you will no longer receive dividend payments.

60
Q

Why might an issuer call preferred stock?

A

To save money. Preferred stock does not have an end date or maturity; the issuer is essentially committed to making dividend payments indefinitely unless they call the shares.

61
Q

Two reasons issuers typically call their preferred stock:

A
  1. If they have the funds available to make the call, the issuer may simply want to avoid making future dividend payments.
  2. More commonly, the issuer can “refinance” their preferred stock.
62
Q

What does it mean to “refinance”?

A

To get rid of older, more expensive obligations, and replace them with a new, less expensive obligation.

63
Q

How does an issuer refinance its preferred stock?

A

First, the issuer issues new shares of preferred stock at the current interest rate. Next, the issuer calls the older callable preferred stock (with the higher rate) using the proceeds from the sale of the new preferred shares.

64
Q

Who is a call feature beneficial to?

A

The issuer.

65
Q

What is “call protection”?

A

The amount of time before a security can be called.

66
Q

Why is callable preferred stock issued with higher dividend rates?

A

To compensate investors for the callable risk.

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