Companies raise capital in two primary ways. One way is to issue equity, which is known as stock, and the other is to incur debt, which is often done by selling bonds. Preferred stock is sometimes referred to as a hybrid since it has both the characteristics of common stock and bonds. Preferred stock allows the holder to have rights not available to the common stockholders. One important right is a preference to dividends. Preferred stock doesn’t offer the same potential for profit as common stock, but it’s a more stable investment vehicle because it guarantees a regular dividend that isn’t directly tied to the market like the price of common stock. In the event of a company’s liquidation, preferred stockholders get paid before those who own common stock. In addition, if a company goes bankrupt, preferred stockholders enjoy priority distribution of the company’s assets, while holders of common stock don’t receive corporate assets unless all preferred stockholders have been compensated. The price of preferred stock is tied to interest rate levels, and tends to go down if interest rates go up and to increase if interest rates fall.
Prior Preferred Stock
Companies are likely to have various classes of preferred stocks outstanding at one time (e.g. Class X, Class Y, “Z” Series, etc.). From this lot, the company may prioritize one stock. After prioritization, in case of insufficient funds to meet the dividend payments of all preferred classes, the company only pays dividends on the prior preferred class of shares. The upside to being a prior preferred stock is that the dividends are relatively more secure; on the flip side, they usually have a lower yield than the other classes because of the stability of payments.
Preference Preferred Stock
These issues receive preference over all other classes of the company’s preferred except for the prior preferred. If the company issues more than one issue of preference preferred, then the various issues are ranked by their relative seniority. One issue is designated first preference, the next senior issue is the second and so on.
Straight Preferred Stock
Straight or fixed-rate perpetual stocks, which have no maturity date because the dividend rate is set for the life of the issue.
Term Preferred Stock
Term or retractable preferred stocks are issued with maturity date.
Callable Preferred Stock
Callable preferred stock allows the company to call or redeem at its option the outstanding preferred shares under conditions specified by the stock contract. In other words, Sometimes a company retains the right to redeem or “call” preferred shares of stock as long as they pay for the shares at or above the market price.
Participating Preferred Stock
Holders of participating preferred stock are entitled to share any dividend available after the preferred stockholders have been paid at a rate equal to that paid for preferred stock. Which means shareholders receive extra dividends over their nominal ones when the company makes an extra profit and the board of directors declares dividends. For Example, If preferred stock is paid at 10%, any amount in excess of 10% paid to common shareholders is shared between the preferred and common stockholders.
Adjustable-Rate Preferred Stock
Holders of adjustable-rate preferred stock are tied to Treasury bill or other rates. The dividend is augmented based on the shifts in interest rates, determined by an established formula.
Convertible Preferred Stock
Holders of convertible preferred stock have the option to exchange their preferred shares for a specified number of company’s common stock at the set rate.
Cumulative Preferred Stock
Holders of cumulative preferred stocks are owed dividend in arrears for years the dividend is not declared, that is, not passed. In other words if a dividend on a cumulative preferred is not paid, it will accumulate for future payment but it must be paid off before any dividend payments are made to the common stockholders. For example: holders of 5,000 shares of 10%, Rs 100 par cumulative preferred stocks are entitled to a Rs 10 annual dividend per share. If dividend is passed for 2 years, the preferred shareholders are entitled to dividend in arrears of Rs 100,000 (Rs10 x 5,000 shares x 2 years) and Rs 50,000 for the third year. The amount paid in the third year is Rs150,000.