Quick Answer
Preferred stock is an equity security that pays a fixed dividend, usually on
Quick Answer: Preferred stock is an equity security that pays a fixed dividend, usually on $100 par, and trades like a bond because its price is interest-rate sensitive. It ranks senior to common stock for dividends and in liquidation, but junior to all debt, and it generally carries no voting or pre-emptive rights.
00 par, and trades like a bond because its price is interest-rate sensitive. It ranks senior to common stock for dividends and in liquidation, but junior to all debt, and it generally carries no voting or pre-emptive rights.The rest of this unit builds on that one distinction: preferred stock sits between debt and common equity, borrowing bond-like pricing behavior while remaining a class of ownership stock, not a creditor claim.
What Is Preferred Stock?
- Preferred stock is an equity security representing ownership in a corporation. It is NOT debt
- Pays a fixed dividend stated as either a percentage of par value or a flat dollar amount
- Par value is typically $100 per share (unlike common stock, which often has $1 par or no par value)
- Trades in the secondary market like common stock, but price behavior is more like bonds because it is interest-rate sensitive
- Because the dividend is fixed, preferred stock is classified as a fixed-income security despite being equity
Think of it this way: If you own a preferred stock paying $6/year and new preferred shares start paying $8/year, your $6 share becomes less attractive. Its price drops so the yield rises to compete. That is why preferred stock is interest-rate sensitive, just like bonds.
Example: A 6% preferred stock with $100 par pays $6.00 per year in dividends ($1.50 per quarter), regardless of how well or poorly the company performs.
Exam Tip: Gotchas
- Preferred stock pays a FIXED dividend. Do not confuse it with common stock dividends, which vary.
- Par value for preferred is typically $100, not $1,000 (that is bonds).
How Does Preferred Stock Differ From Common Stock?
Preferred stock differs from common stock in several key ways:
| Feature | Preferred Stock | Common Stock |
|---|---|---|
| Dividends | Fixed rate, paid before common if declared | Variable, declared by board |
| Voting rights | Generally none | Yes (statutory or cumulative) |
| Growth potential | Limited (trades near par) | Unlimited upside |
| Liquidation priority | Senior to common | Residual claim (last) |
| Price sensitivity | Interest rates (like bonds) | Earnings and market sentiment |
| Pre-emptive rights | No | Yes (right to maintain proportional ownership) |
Key distinctions:
- Preferred stockholders do not have pre-emptive rights; they cannot maintain their proportional ownership when new shares are issued
- Preferred stockholders generally cannot vote unless the issuer has missed a specified number of dividend payments (contingent voting rights)
- Preferred stock offers income stability but sacrifices growth potential. The fixed dividend is both its benefit and its limitation
Exam Tip: Gotchas
- Preferred stock is equity, not debt. Even though it behaves like a bond (fixed income, interest-rate sensitive, trades near par), preferred stockholders are owners, not creditors. In bankruptcy, preferred is paid AFTER all bondholders and creditors.
What Should You Check on Exam Day?
- Preferred stock is equity, not debt, even though its price behaves like a bond's.
- Par value is typically $100, not $1,000 (the bond convention).
- Preferred stockholders generally cannot vote and have no pre-emptive rights.
- In bankruptcy, preferred is senior to common but paid after every bondholder and creditor.