Chapter 10 Appendix The Special Case of Preferred Stock

1. Chapter 10 AppendixThe Special Case of Preferred Stock

2. It is neither wealth nor splendor, but tranquility and occupation, which give happiness. - Thomas Jefferson

3. Outline • Introduction • Types of preferred stock

4. Introduction • Preferred stock is an equity security • Preferred stock is classified as a fixed-income security from an investment perspective • Utility companies are common issuers of preferred stock

5. Introduction (cont’d) • Characteristics of preferred stock: • Pay higher dividends than common stock • Preferred shareholders have priority over common shareholders in the event of corporate liquidation • Preferred shareholders must receive their dividends before common shareholders receive anything

6. Introduction (cont’d) • Characteristics of preferred stock (cont’d): • Most preferred stock receives a set annual dividend • Preferred stock normally provides no growth of income and no price appreciation • The value of preferred stock is influenced by interest rate movements

7. Introduction (cont’d) • Characteristics of preferred stock (cont’d): • A corporation that owns less than 20% in a corporation can deduct 70% of the dividends received

8. Types of Preferred Stock • Straight preferred stock • Convertible preferred stock • Participating preferred stock • Cumulative preferred stock

9. Straight Preferred Stock • Straight preferred stock pays a fixed annual dividend in perpetuity • Straight preferred stock is the simplest type of preferred stock

10. Convertible Preferred Stock • Convertible preferred stock is like straight preferred stock • Additionally, the owner has the option to exchange the shares for a set number of common stock or some other security

11. Participating Preferred Stock • Participating preferred stock issues have the provision that shareholders may receive additional dividends in very profitable years • Participating preferred stock is less susceptible to interest rate risk than straight preferred stock

12. Cumulative Preferred Stock • Cumulative preferred stock accrues any missed dividend amounts • The firm must pay past dividends before paying any common dividends