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8.3 Preferred Shares

Explore the features and benefits of preferred shares, understand different types of preferred shares, and learn how to differentiate among them.

Preferred Shares

3 | Describe the features and benefits of preferred shares.

Preferred shares, often referred to as preferreds, are a type of equity security that bring along several distinct features and benefits compared to common shares. Here are the key characteristics:

Features

  • Dividend Priority: Preferred shareholders receive dividends before common shareholders. The dividends are usually fixed and can be cumulative or non-cumulative.
  • Fixed Dividend: Unlike common shares, preferred shares often come with a fixed dividend rate, which offers more predictable income.
  • Preference in Assets upon Liquidation: In the event of liquidation, preferred shareholders have a higher claim on assets than common shareholders.
  • Callable: Many preferred shares can be called (redeemed by the issuer) after a certain date at a predetermined price.
  • Convertible: Convertible preferred shares can be converted into a predetermined number of common shares, offering potential for capital appreciation.

Benefits

  • Steady Income Stream: Due to the fixed dividend, preferred shares can provide a steady income stream, which is particularly attractive to income-focused investors.
  • Lower Volatility: Preferred shares tend to be less volatile than common shares due to the fixed dividend payments and priority over common shares in the event of liquidation.
  • Higher Claim in Bankruptcy: Preferred shares, theoretically, have a better chance of some recovery in bankruptcy or liquidation scenarios compared to common shareholders.
  • Potential Tax Advantages: In some jurisdictions, dividends from preferred shares may be more tax-efficient compared to other types of fixed-income securities.

4 | Differentiate among the types of preferred shares.

Several types of preferred shares exist, each with unique characteristics. Here’s a breakdown of some common types:

Types of Preferred Shares

  • Cumulative Preferred Shares: These shares accumulate unpaid dividends. If a company skips a dividend payment, it must make up for it in the future before any dividends can be paid to common shareholders.
  • Non-Cumulative Preferred Shares: These shares do not accumulate unpaid dividends. If a dividend payment is missed, shareholders do not have a right to claim it in the future.
  • Participating Preferred Shares: Holders of these shares may receive extra dividends based on a specific condition, typically tied to the company’s overall financial performance, alongside the fixed dividend.
  • Convertible Preferred Shares: These can be converted into a set number of common shares, providing an opportunity for capital appreciation if the common shares rise in value.
  • Callable Preferred Shares: Issuers can redeem these shares at a predetermined price after a certain date, which can be advantageous if interest rates decline.
  • Adjustable-Rate Preferred Shares: The dividend rate can be adjusted based on specific indices or interest rates, which can offer some protection against interest rate fluctuations.

Evaluating Preferred Shares

To effectively evaluate preferred shares, it’s crucial to review the notes to a company’s audited financial statements, which provide detailed terms and conditions attached to the preferred shares. These notes clarify dividend policies, convertibility clauses, and other pertinent information.

Key Takeaways

  • Priority on Dividends: Preferred shares typically offer priority on dividends over common shares.
  • Less Volatility: Preferred shares tend to be less volatile, providing a lower-risk investment compared to common shares.
  • Various Types: There are several types of preferred shares catering to different risk appetites and investment goals, such as cumulative, non-cumulative, participating, convertible, callable, and adjustable-rate shares.

Frequently Asked Questions (FAQs)

Q: What are preferred shares?

  • A: Preferred shares are a type of equity with fixed dividends and priority over common shares in dividend distribution and asset liquidation.

Q: What is the main benefit of holding preferred shares?

  • A: The primary benefit is the fixed dividend, offering a predictable income stream.

Q: Can preferred shares be converted into common shares?

  • A: Some preferred shares, known as convertible preferred shares, can be converted into a predetermined number of common shares.

Q: How are cumulative preferred shares different from non-cumulative ones?

  • A: Cumulative preferred shares accrue unpaid dividends to be paid in the future, while non-cumulative shares do not.

Q: What does it mean if preferred shares are callable?

  • A: Callable preferred shares can be redeemed by the issuer at a set price after a specific date.

Keep exploring each type of preferred share further to understand which best meets your investment goals and risk tolerance.


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## Which of the following is not typically classified as a preferred share? - [ ] Class A shares - [ ] Ordinary shares - [ ] Subordinated shares - [x] Restricted shares > **Explanation:** Restricted shares are generally not considered preferred shares or common shares. Preferred shares usually fall under other types such as Class A, ordinary, and subordinated shares. ## What is the primary resource you should consult to determine the true characteristics of a company's shares? - [ ] Press releases - [ ] Company’s website - [x] Notes to a company's audited financial statements - [ ] Shareholder’s meeting minutes > **Explanation:** The notes to a company's audited financial statements provide detailed information about the characteristics and rights attached to its various classes of shares. ## What type of shares are preferred shares often compared to? - [ ] Mutual funds - [ ] Exchange-Traded Funds (ETFs) - [x] Common shares - [ ] Bonds > **Explanation:** Preferred shares are often compared to common shares because both represent equity ownership in a company, but with different characteristics and benefits. ## Which of the following is a key benefit of holding preferred shares? - [ ] Unlimited potential for price appreciation - [ ] Voting rights at company meetings - [x] Priority in dividend payments - [ ] Priority in assets in the event of liquidation > **Explanation:** Holders of preferred shares often have priority over common shareholders in receiving dividends and during asset distribution in the event of the company's liquidation. ## Which of the following is true about the term "preferred shares"? - [ ] It indicates that these shares are more desirable than common shares in all aspects - [ ] The name itself is sufficient to determine the attributes of the shares - [ ] Preferred shares come with voting rights - [x] You must look beyond the name to determine the true characteristics of the shares > **Explanation:** The name "preferred shares" does not provide a complete picture of their attributes. Detailed information must be obtained from the financial statements or other official documents. ## What do "preferred shares" generally refer to in financial terminology? - [ ] Shares that have special privileges over common shares - [x] Shares not classified as common or restricted shares - [ ] Shares with mandatory dividends - [ ] Shares with higher market value > **Explanation:** In financial terminology, preferred shares are considered all shares not classified as common or restricted shares. ## What is one characteristic that is often missing from preferred shares compared to common shares? - [ ] Fixed dividend rate - [ ] Priority in asset distribution - [x] Voting rights - [ ] Fixed maturity date > **Explanation:** Preferred shares often lack voting rights, which are usually provided to holders of common shares. ## What is one typical feature of subordinated shares that distinguishes them from common shares? - [x] Subordinated claims on assets - [ ] Higher voting rights - [ ] Higher market value - [ ] Guaranteed dividends > **Explanation:** Subordinated shares have claims on a company's assets that are below those of common shares, meaning they are paid out after common shareholders in the event of liquidation. ## Which type of shares generally has a fixed dividend rate? - [ ] Common shares - [ ] Discounted shares - [ ] Restricted shares - [x] Preferred shares > **Explanation:** Preferred shares typically come with a fixed dividend rate, providing a more stable income stream for shareholders compared to common shares. ## What concept should you rely on to fully understand the characteristics of a particular class of shares? - [ ] The name given to the shares - [ ] Press releases from the company - [x] Detailed notes and disclosures in the company’s audited financial statements - [ ] Market trends and analysts' opinions > **Explanation:** To fully understand the characteristics of a particular class of shares, it's essential to refer to the detailed notes and disclosures in the company's audited financial statements, as names alone are not sufficient.

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In this section

  • 8.3.1 Preferred Shareholder’s Claim To Assets
    Understanding the preferred shareholder's claim to assets, their priority status over common shares in the event of bankruptcy, and their entitlement to fixed dividend payments.
  • 8.3.10 Other Types Of Preferred Shares
    Learn about the various less common types of preferred shares such as participating preferred shares and deferred preferred shares, including their features, advantages, and practical applications in investment strategies.
  • 8.3.2 Why Companies Issue Preferred Shares
    In-depth exploration of why companies issue preferred shares as opposed to debt or common shares, evaluating the benefits and considerations involved.
  • 8.3.3 Why Investors Buy Preferred Shares
    This section explores the reasons why investors, including both individual and institutional investors, buy preferred shares, highlighting benefits such as dividend tax credits and preferential tax treatment.
  • 8.3.4 Preferred Share Features
    Learn about the key features of preferred shares including cumulative and non-cumulative features, callable and non-callable features, voting privileges, and special funds like purchase and sinking funds.
  • 8.3.5 Straight Preferred Shares
    Learn about Straight Preferred Shares, their features, market behavior, and benefits for investors. Explore an example to understand yield dynamics.
  • 8.3.6 Convertible Preferred Shares
    An in-depth guide to understanding convertible preferred shares, their characteristics, benefits, and how they differ from straight preferred shares.
  • 8.3.7 Retractable Preferred Shares
    Learn all about Retractable Preferred Shares, their characteristics, and examples. Understand key features that affect their value and how they compare to other financial instruments in volatile market conditions.
  • 8.3.8 Floating-rate Preferred Shares
    A comprehensive guide to understanding floating-rate preferred shares, including their market conditions, examples, characteristics, and implications for buyers.
  • 8.3.9 Foreign-pay Preferred Shares
    Learn about the structure, benefits, and risks of foreign-pay preferred shares issued by Canadian companies, along with an illustrative example.
Tuesday, July 23, 2024