Quick Answer
Because preferred stock pays a fixed dividend and has no maturity date, its price moves inversely with interest rates, like a bond that never matures. Current yield (annual dividend divided by market price) is the standard yield measure, since there is no yield to maturity to calculate.
Preferred's lack of a maturity date is the key difference from a bond with the same coupon: a bond eventually "pulls to par" as it approaches maturity, capping how far its price can drift, but preferred stock has no such anchor.
How Does Preferred Stock Price Move With Interest Rates?
Because preferred stock pays a fixed dividend, its market price moves inversely with interest rates, just like bonds.
- When interest rates rise → Preferred stock prices fall
- New issues offer higher dividends, making existing lower-dividend shares less attractive
- When interest rates fall → Preferred stock prices rise
- Existing higher-dividend shares become more valuable when new issues pay less
Why This Matters for Different Types
| Type | Interest-Rate Sensitivity |
|---|---|
| Fixed-rate preferred | High - price fluctuates inversely with rates |
| Adjustable-rate preferred | Low - dividend resets to match market rates, so price stays near par |
| Callable preferred | Moderate - price rises when rates fall, but issuer may call |
Key insight: Adjustable-rate preferred has more price stability because the dividend adjusts to match market rates. Fixed-rate preferred carries more interest-rate risk because the dividend is locked in.
Exam Tip: Gotchas
- Preferred stock has no maturity date, so it cannot "pull to par" like a bond held to maturity. For fixed-rate preferred, this can make interest-rate risk greater than a bond with the same coupon.
- Adjustable-rate preferred has lower interest-rate risk because the dividend resets to match market rates. Fixed-rate preferred carries the most interest-rate sensitivity.
How Do You Calculate Preferred Stock Yield?
Current yield is the primary yield measure for preferred stock. Because preferred stock typically has no maturity date, there is no yield to maturity (YTM) calculation.
Current Yield Formula
Current Yield = Annual Dividend / Market Price
Examples
| Scenario | Annual Dividend | Market Price | Current Yield |
|---|---|---|---|
| At par | $6.00 | $100.00 | 6.00% |
| At discount | $6.00 | $95.00 | 6.32% |
| At premium | $6.00 | $105.00 | 5.71% |
How Does Price Relate to Yield?
- If preferred trades at a discount to par → Current yield is higher than the stated dividend rate
- If preferred trades at a premium to par → Current yield is lower than the stated dividend rate
- If preferred trades at par → Current yield equals the stated dividend rate
This follows the same inverse relationship as bonds: price down = yield up, price up = yield down.
Worked Example
A 5% preferred stock has a $100 par value. It currently trades at $90.
- Annual dividend = 5% x $100 = $5.00
- Current yield = $5.00 / $90.00 = 5.56%
- The stated rate is 5%, but because the investor paid less than par, the effective yield is higher
Exam Tip: Gotchas
- Current yield is the primary yield measure for preferred stock. There is no yield to maturity (YTM) because preferred stock typically has no maturity date.
- Discount to par = yield HIGHER than stated rate; premium = yield LOWER. If you paid less than par, you're getting the same dividend on a smaller investment, so the effective return is higher.
What Are the Investment Implications?
Understanding the interest-rate relationship helps you recommend preferred stock appropriately:
- Falling rate environment: Fixed-rate preferred benefits (price appreciation + steady income)
- Rising rate environment: Adjustable-rate preferred is more appropriate (price stability)
- Callable preferred in falling rates: Issuer may call, limiting upside. The investor receives the call price but loses the income stream.
Exam Tip: Gotchas
- Callable preferred caps your upside when rates fall. The issuer will call the shares and reissue at a lower dividend rate, so the price appreciation is limited to the call price.
What Should You Check on Exam Day?
- Preferred stock price and interest rates move inversely, like a bond.
- No maturity date means no YTM; current yield (dividend / market price) is the exam's yield measure.
- Discount to par pushes yield above the stated rate; premium pushes it below.
- Adjustable-rate preferred trades price stability for a variable dividend; fixed-rate preferred keeps the certain payment but takes the full rate risk.