Equities - Preferred Stock

Conversion Math A corporation has issued $100 par, 6 1/2% cumulative convertible preferred stock, callable at par. The preferred is convertible into 2 shares of common stock. Currently, the preferred stock is trading at $100 while the common stock is trading at $50. If a customer buys 100 preferred shares, converts, and then sells the common stock in the market, the profit or loss is (ignoring commissions): A $0 B $1,000 loss C $5,000 gain D $10,400 gain

A If the customer buys 100 shares of the preferred stock, he or she will pay 100 x $100 per share = $10,000. Since each share of preferred is convertible into 2 common shares, the 100 preferred shares will be converted into 2 x 100 = 200 common shares. The sale of 200 common shares at the current market price of $50 will yield $10,000. The net profit is: $10,000 - $10,000 = $0. Here, there is a wash, as both the common and preferred are trading at parity.

Features of Preferred Stock Which statement is TRUE regarding preferred stock payments? A Preferred dividends are usually higher than those paid to common B Preferred dividends tend to grow over time C Preferred dividends are paid quarterly D Preferred interest is paid semi-annually

A Preferred dividends are typically fixed and are generally higher than those paid to common stockholders. Preferred dividends (NOT interest) are, in most cases, paid semi-annually, as compared to common stock dividends that are paid quarterly.

Preferred Dividend Features ABC gold mining company has issued a preferred stock. Dividends on the issue may be paid as: A Cash only B Cash or additional preferred shares of ABC C Cash or additional common shares of ABC D Cash or gold bullion

A Preferred dividends may only be paid in cash. This differs from common stock, which can be paid a dividend in the form of cash, stock, or product.

Forced Conversion A corporation has issued $100 par, 8% cumulative convertible preferred stock, callable at par. The preferred is convertible into 1.4 shares of common stock. Currently, the preferred stock is trading at $102 while the common stock is trading at $75.50. The corporation calls the preferred stock at par plus accrued dividends of $2 per share. The corporation is making a(n): A tender offer B forced conversion C advance refunding D simultaneous transaction

B

Summary During periods of stable interest rates, which type of preferred stock will have the greatest price volatility? A Cumulative B Participating C Callable D Adjustable Rate

B

Taxation of Preferred Dividends Which statements are TRUE regarding the taxation of dividends received by investors? I Individuals cannot exclude any dividends received from taxation II Individuals can exclude 50% of dividends received from taxation III Corporations cannot exclude any dividends received from taxation IV Corporations can exclude 50% of dividends received from taxation A I and III B I and IV C II and III D II and IV

B

Preferred Stock Yields ABC 10% $100 par preferred is trading at $120 in the market. The current yield is: A 5% B 8.33% C 10% D 12%

B Current yield: Annual Income/Market Price 10/120 = 8.33%

Cumulative Preferred ABC Company has issued 13%, $100 par cumulative preferred stock. Two years ago, ABC paid a preferred dividend of $8. Last year, it paid a preferred dividend of $12 per share. This year, ABC wishes to pay a common dividend. In order to make the distribution to common shareholders, each preferred share must be paid a dividend of: A $14 B $19 C $20 D $26

B Since the preferred stock is cumulative, to make a dividend distribution to common shareholders, the company needs to pay all back, unpaid dividends plus this year's dividend (before a common dividend can be paid). The stated dividend rate on the preferred is 13% based on $100 par. Two years ago, 8% was paid, so 5% was omitted that must be paid. Last year, the corporation only paid 12%, so there is another 1% that must be paid. Also, this year's dividend of 13% must be paid. The total dividend that must be paid is 19% or $19 per preferred share before a common dividend can be paid.

Anti Dilutive Covenant A corporation issues $100 par convertible preferred stock, convertible at $20 per share when the common stock is trading at $10. The preferred is issued under an "anti-dilutive covenant." If the company declares a 25% stock dividend, which statements are TRUE? I The conversion price is adjusted to $16 II The conversion price is adjusted to $25 III The conversion ratio is adjusted to 4:1 IV The conversion ratio is adjusted to 6.25:1 A I and III B I and IV C II and III D II and IV

B Under an "anti-dilutive" covenant, if there is a stock split or stock dividend resulting in the issuance of additional common shares, the conversion price and hence the conversion ratio are adjusted to reflect the fact that the market price of each common share will drop on the ex date. Prior to the stock dividend, the conversion price was $20 per share. If there is a 25% stock dividend, the new conversion price will be adjusted to $20/1.25 = $16 per share. Since each preferred share is $100 par, the new conversion ratio will be $100/$16 = 6.25.

Conversion Ratio A corporation issues $50 par convertible preferred stock, convertible at $20 per share, when the market price of the common is currently $10. Which statement is TRUE? A The conversion ratio is 10:1 B The conversion ratio is 5:1 C The conversion ratio is 2.5:1 D The conversion ratio is 2:1

C Conversion Ratio = Par/Conversion Price Conversion Price = Par/Conversion Ratio

Callable Preferred If interest rates fall, issuers most likely will call: A all preferred issues B any preferred issue close to maturity C preferred issues trading at a premium D preferred issues trading at a discount

C If interest rates fall, issuers most likely will "call in" old high rate preferred and replace it by selling new preferred at the lower current rates. High rate preferred will sell at a premium if market interest rates are dropping. Preferred stocks do not have a stated maturity.

Convertible Preferred Which statement is TRUE when comparing convertible preferred stock and non-convertible preferred stock? A Convertible preferred issues will have a higher yield than similar non-convertible yields of the same issuer B Non-convertible preferred shares and convertible shares of the same issuer typically have the same yield C Non-convertible preferred shares will have a higher yield than similar convertible shares of the same issuer D Non-convertible preferred stockholders will benefit as the common stock price rises

C Non-convertible preferred yields are higher than convertible yields. A non-convertible preferred stockholder gets a fixed rate of return without any growth potential

Interest Rate Movements and Preferred Stock Prices As interest rates rise, preferred stock prices will: A remain unaffected B rise C fall D fluctuate

C Preferred stock is a fixed income security whose prices move inversely with interest rates. As interest rates rise, preferred stock prices fall, so that the preferred will give a yield that is competitive with the current market.

Participating Preferred All of the following are types of preferred stock EXCEPT? A Performance B Participating C Cumulative D Refundable

D There is no such thing a refundable preferred stock. Participating preferred (also known as performance preferred) allows the holder to receive additional dividend distributions from the issuer if the issuer is having a good year. Cumulative preferred "accumulates" any unpaid dividends. Before a common dividend may be paid, all accumulated dividends must be paid to cumulative preferred shareholders.

Preferred Dividend Payments A customer buys 100 shares preferred at $110 per share. The par value is $100. The dividend rate is 5%. Each dividend payment will be: A $250 B $275 C $500 D $550

The annual rate is 5% X $100 par value = $5 per share X 100 shares = $500. Since preferred dividends are paid semi-annually, each payment is $250.