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Fixed Income Securities (Bonds): Preferred Securities

What is a Preferred Security?

Preferred stock is a type of stock issued by public companies, which grants the stockholder a greater claim to dividends or assets distributed by the corporation. The dividends of preferred stock are generally higher than that of common stock, with the interest set being either fixed, or set by major interest rates, such as the Fed rate or the LIBOR. Ownership of preferred stock does not, however, grant the holder ownership in the company, except in very limited terms, in some instances. Further, public companies are not required to pay dividends to holders of preferred stock on a periodical basis, but at the decision of the executive board. They are, as a result, something of a hybrid of a stock and a bond.

When public companies face financial difficulty, including bankruptcy, holders of preferred stock are generally given priority if the company liquidates its assets and pays dividends to shareholders. However, bondholders are given priority over all shareholders when this happens. As a result, preferred shares are generally assigned lower credit ratings and lower interest rates than corporate bonds.

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Types of Preferred Stock

There are five major types of preferred stock:

  • Cumulative - Most shares of preferred stock are cumulative. If a public company is unable to pay expected dividends, holders of cumulative shares are given priority when dividend payments resume.
  • Callable - Most preferred shares are also callable, meaning the issuer has a right to redeem the stock, at a date and price specified in the offering prospectus.
  • Convertible - Convertible shares can be converted by the shareholder to common shares, usually at a specific conversion price specified in the offering prospectus.
  • Participating - Participating shares have a fixed dividend rate. This is not common with preferred stock, which generally has a dividend rate set by a major interest rate.
  • Adjustable-Rate Preferred Stock - This type of preferred stock adjusts its dividend rate over time, usually with a yield aligned to U.S. government securities or the company's credit rating.

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