Preferred Stock

The whole unit on one sheet: what preferred is, its types and rights, the conversion math, and why fixed-rate prices fall when rates rise.

Core Concepts

• Preferred stock is an equity security (ownership), NOT debt, that pays a fixed dividend as a percentage of par or a flat dollar amount.
• Par value is typically $100 per share (bonds are $1,000). A 6% preferred at $100 par pays $6.00/year ($1.50/quarter), regardless of company performance.
• Classified as a fixed-income security despite being equity, because the dividend is fixed and the price is interest-rate sensitive.
• Generally nonvoting; no pre-emptive rights. Priority over common on dividends and in liquidation.

The Five Types

• Cumulative: skipped dividends accumulate as dividends in arrears and must be paid (arrears first, then current preferred) before any common dividend. Arrears are footnote-disclosed, not a balance-sheet liability.
• Non-cumulative (straight): a skipped dividend is gone forever; more risk to the investor.
• Participating: gets its stated dividend first, then also shares in extra distributions alongside common (rarely issued).
• Convertible: holder's option to swap for common at a set ratio; pays a lower dividend because the conversion feature has value.
• Callable: issuer's option to redeem at the call price (at or slightly above par); pays a higher dividend for call risk. Issuer calls when rates fall.
• Adjustable-rate (floating-rate): dividend resets to a benchmark, so price stays near par with less interest-rate risk.

The One-Liners That Win Points

• Preferred is equity, not debt. Holders are owners, paid AFTER all bondholders and creditors in bankruptcy.
• Callable = issuer's right; Convertible = holder's right. Issuers call when rates fall; holders convert when common rises.
• "Preference" is not "guarantee." The board must declare the dividend; if it declares none, nobody gets paid.
• Liquidation order: secured creditors, unsecured creditors, subordinated debt, preferred, then common.
• Discount to par = current yield higher than the stated rate; premium = yield lower; at par they match.
• Pre-emptive rights belong to common, not preferred.

Numbers to Lock In

Convertible Parity Math

• $100 par, conversion price $25: conversion ratio = 4 shares ($100 / $25).
• Common at $30: conversion value = 4 x $30 = $120; parity price of preferred = $30 x 4 = $120.
• Convert when conversion value exceeds the preferred's market price (preferred at $100, value $120 = $20 gain), but converting forfeits the fixed dividend.
• Anti-dilution covenant protects the holder on splits/stock dividends: after a 2-for-1 split, conversion ratio increases, conversion price decreases, and conversion value stays the same. Multiply the pre-split ratio by the split factor.

Top Gotchas

• Cumulative dividend order is arrears first, then current preferred, then common; if the declared amount cannot cover both preferred pieces, common gets nothing.
• Conversion is a one-way street. Once you convert to common, you cannot convert back, and you lose the preferred dividend and liquidation preference.
• At parity, preferred market price equals its conversion value; the two are equally valued.
• Preferred has no maturity date, so it cannot "pull to par." That can make fixed-rate interest-rate risk greater than a same-coupon bond.
• Callable preferred caps upside when rates fall: the issuer calls and reissues at a lower rate, so the investor gets the call price but loses the income stream.
• Sinking funds reduce credit risk but add call risk on individual shares.

One-Breath Recap

Preferred stock is fixed-income-flavored equity: it pays a fixed dividend, ranks above common but below all debt, and usually cannot vote. Learn the five types, the conversion parity formulas, and the rule that fixed-rate preferred prices fall when rates rise, and this unit answers itself.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Preferred Stock unit for the complete lesson.