Chapter 16: Investing in Preferred Stocks
A $2.50 preferred stock (meaning the stock pays a dividend of $2.50 per year) would be priced at $20.83 if the prevailing market yield were __________%.
12
A $________ preferred stock (meaning the stock pays a dividend of $_________ per year) would be priced at $20.83 if the prevailing market yield were 12%.
2.50
A $2.50 preferred stock (meaning the stock pays a dividend of $2.50 per year) would be priced at $__________ if the prevailing market yield were 12%.
20.83
Assume, for example, that a firm normally pays a $1 quarterly dividend on its preferred stock but has missed the dividend for 3 quarters in a row. In this case, the firm has preferred dividends in arrears of $___ a share. It must meet these past dividends, along with the next quarterly dividend, before it can pay dividends to common shareholders
3
If a stock that pays $3 in dividends is currently priced at $28, and its expected future value is $50, then its Expected Return is __________%.
30.3
Suppose a preferred stock pays $3 in dividends and its yield is expected to decline to 6% within the next 3 years. If such market rates prevail, then 3 years from now, the issue will have a market price of $_______. Using this market price, the expected return of this Preferred Dividend is ___________%.
30.3
Alcoa Inc. has preferred shares outstanding with a par value of $100. The dividend rate on these shares, expressed as a percentage of par value, is 3.75%. This means that each Alcoa preferred share receives $3.75 in dividends per year (0.0375 * $100). In August 2012, these shares had a market price of $84.69. Dividing the dividend payments by the market price of the shares, we can determine that the dividend yield is ________%
4.43
If the annual dividend of a preferred stock is $3.75 and the market price is $84.68, then the Dividend Yield is ____________%
4.43
Suppose a preferred stock pays $3 in dividends and its yield is expected to decline to 6% within the next 3 years. If such market rates prevail, then 3 years from now, the issue will have a market price of $_______.
50
Over the last 110 years, the yield on preferred stocks has averaged just over __________%.
6
Known as ___________ (or floating rate) ____________, these issues adjust their dividends periodically in line with yields on specific Treasury issues, although minimum and maximum dividend rates are usually established as safeguard for investors and issuers.
Adjustable Rate Preferred Stock
There's far less price volatility with ______________s than with fixed-rate preferreds.
Adjustable Rate Preferred Stock
Preferred stocks may be a form of equity, they behave in the market more like a ___________ than a stock.
Bond
_________________ (Net Asset Value) of a preferred stock is a measure of the amount of debt free assets supporting each share of preferred stock.
Book Value
Since the early 1970s, it has become increasingly popular to issue preferred stocks with ____________s
Call Feature
As with bonds, the ____________ of a preferred is made up of the par value of the issue and a call premium that may amount to as much as 1 year's dividends.
Call Price
Rather than assuming a "safe" buy-and-hold position, the investor who trades on movements in interest rates adopts an aggressive Short Term trading posture. This is done for one major reason: ____________s.
Capital Gain
Callable preferreds are usually issued on a(n) __________ basis, which means they cannot be retired for a certain number of years after the date of issue. After the deferral period, usually 5 to 7 years, the preferreds become freely callable.
Deferred-Call
Generally speaking, lower agency ratings reduce the market yield of an issue and increase its interest sensitivity.
F
Other things being equal the quality of an issue improves as the margin by which the book value exceeds the par value decreases.
F
Freely Callable preferred stocks normally provide ________ yields than noncallable issues because of their greater call risk.
Higher
The yields on freely callable preferreds are generally ____________ than those on noncallable issues
Higher
Because preferred stocks contain elements of both debt and equity, they are viewed as a type of _______________.
Hybrid Security
The price of a preferred stock is directly related to the issue's level of ______________. That is, other things being equal, the higher the dividend payment, the higher the market price of an issue.
Income
Another reason for investing in preferred stocks is the level of safety they offer investors. That is, despite a few well publicized incidents, HIGH GRADE preferred stocks have an excellent record of meeting dividend payments in a timely manner--certainly an important consideration to ____________investors.
Income Oriented
Another drawback of preferred stocks is their susceptibility to _____________and high interest rates.
Inflation
Just like bond prices, the price behavior of a high grade preferred stock is ____________ related to the market interest rates.
Inversely
Whenever you leave one of the top 4 agency ratings, you should recognize the speculative position you are assuming. This is especially so with preferreds, since their dividends lack ____________________.
Legal Enforcement
Very high _______________s of bonds are not available with preferreds because they fall under the same, less generous margin requirements as common stocks.
Leverage Rate
Some special breeds of preferred stocks offer not only attractive yields but also monthly income. One of these is a type of hybrid security known as a(n) ______________.
Monthly Income Preferred Stock (MIPS)
When a company has more than one issue of preferred stock outstanding, it sometimes issues ______________(or prior preferred) _____________. Essentially, this stock has seniority over other preferred stock in its right to receive dividends and in its claim on assets in the event of liquidation.
Preference Preferred Stock
A firm that wants to issue capital but does not want to dilute either the voting rights of existing shareholders or the firm's reported earnings per share may decide to issue ______________s rather than equity (Common Stock).
Preferred Stock
A(n)____________ is a type of security that has some features similar to common stock and other features similar to debt.
Preferred Stock
Because ______________ does obligate a firm to make regular dividend payments but does not offer the firm a tax break, they are issued less often than either debt or common equity.
Preferred Stock
Most ____________s are issued by financial institutions and utilities, though almost any public company can issue them.
Preferred Stock
Without a doubt, the number 1 reason that investors are attracted to _______________s is the current income they provide.
Preferred Stock
_______________s carry fixed dividends that are paid quarterly and are expressed either in dollar terms or as a percentage of the stock's par (or stated) value.
Preferred Stock
Preference stocks should be viewed as ________________s. They're usually easy to pick out in the financial pages because they use the letters pr instead of pf in their quotes.
Senior Preferred Stock
Rather than assuming a "safe" buy-and-hold position, the investor who trades on movements in interest rates adopts an aggressive ___________ trading posture. This is done for one major reason: capital gains.
Short Term
They are used by firms to reduce the cost of financing because _____________ issues generally have lower yields than nonsinking-fund preferreds
Sinking Fund
__________________ Preferred Stocks actually have implied maturity dates.
Sinking Fund
The value of a preferred stock is also affected by issue characteristics such as call features and _____________s
Sinking Fund Provision
This provision specifies how all or a part of an issue will be paid off—amortized—over time.
Sinking Fund Provision
Another disadvantage of preferred stock is that their dividends may be _____________, or passed, if the earnings of the issuer drop off.
Suspended
Another advantage of Preferred Stocks is that preferred shareholders cannot force a firm into bankruptcy if the firm fails to pay dividends on the preferred shares, and that makes preferred more attractive than debt to the issuer.
T
Because preferreds are fixed-income securities, the market behavior of investment-grade issues is closely linked to movements in interest rates. If market interest rates are expected to decline substantially, attractive capital gains opportunities may be realized from preferred stocks.
T
Firms cannot deduct preferred dividends as a business expense.
T
Firms that miss preferred dividend payments generally have to make them up before they can pay dividends to common stockholders.
T
Generally speaking, higher agency ratings reduce the market yield of an issue and increase its interest sensitivity.
T
Neither maturity nor the size of the annual preferred dividend (which is equivalent to a bond's coupon) has any effect on the rate of price volatility. That is, a $2 preferred will appreciate just as much (in percentage terms) as an $8 preferred for a given change in market yields.
T
Normally, the higher the fixed charge coverage, the greater the margin of safety.
T
If the preferred stock carries a ______________provision, the issuing company is under no obligation to make up any of the passed dividends.
noncumulative
Earnings Before Interest and Taxes (EBIT) / [Interest Expense +(Preferred Dividends / 0.65)] = ? Note: The adjustment factor of 0.65 implies a corporate tax of 35%. (i.e., it is the retained bit after tax).
Fixed Charge Coverage
______________ is a measure of how well a firm is able to cover its preferred dividends. Here, attention is centered on the firm's ability to service preferred dividends and live up to the preferred's preferential claim on income.
Fixed Charge Coverage
_______________ is important in determining the quality of a preferred stock.
Fixed Charge Coverage
When interest rates fall, so do the yields on preferreds, as their prices ___________.
Rise
The expected future price of a preferred is important to ___________ traders, than the dividend yield.
Short Term
Preferred stock's biggest advantage is tax treatment.
F
As market yield ____________s, you get higher preferred stock prices, thus giving you the inverse relationship between price and yield.
Fall
As the general level of interest rates rise, so do the yields on preferreds, and their price ___________s accordingly.
Fall
If the price of a preferred ___________s the dividend yield increases.
Fall
Other things being equal the quality of an issue improves as the margin by which the book value exceeds the par value increases.
T
Preferred stock's biggest disadvantage is tax treatment.
T
The yield that a preferred stock offers (and therefore its market value) is a function of not only market interest rates but also the issue's credit quality: The lower the quality of a preferred, the higher its yield.
T
The Dividend Yield is more important to __________ Traders than the expected future price of a preferred.
Long Term
If a company has a fixed charge of __________, that means the company is generating just enough earnings to meet its preferred dividends payment.
1.0
Preferred stocks lack substantial ________________s potential
Capital Gain
Annual Dividend Income / Current Market Price of the Preferred Stock = ?
Dividend Yield
This strategy represents perhaps the most popular use of preferred stocks and is ideally suited for serious long-term investors. High current income is the objective, and the procedure basically involves seeking out those preferreds with the most attractive yields.
Looking For Yields
The yields on noncallable preferreds are generally ____________ than those on Freely Callable issues
Lower
Quality and issue features of preferred stocks have only slight effects on price behavior over time, and they certainly do not compare in importance with the movement of _________s.
Market Yield
If the price of a preferred ________s the dividend yield falls.
Rise
The _____________feature of preferred stocks should increase the price (and in so doing, lower the yield) of these issues.
Cumulative
Although it is possible to enjoy fairly attractive capital gains from preferred stocks when interest rates decline dramatically, these amounts generally do not match the price performance of _____________s
Common Stock
The ______________ of a preferred stock specifies the rights and privileges of preferred stockholders.
Contractual Agreement
A Conversion Preferred Stock has a _______________ that allows the holder to convert the preferred stock into a specific number of shares of the issuing company's common stock.
Conversion Feature
A(n) _____________ has a Conversion Feature that allows the holder to convert the preferred stock into a specific number of shares of the issuing company's common stock.
Convertible Preferred Stock
Unlike the ____________s on a bond, dividends on preferred stock have no legal backing, and failure to pay them does not lead to default.
Coupon Payment
Fortunately for investors, most preferred stocks are issued on a ___________basis.
Cumulative
When preferred stocks are issued on a ____________basis, it means that any preferred dividends that have been passed must be made up in full before dividends can be paid to common stockholders. Any outstanding unfulfilled preferred dividend obligations are said to be in arrears, and so long as dividends on preferred stock remain in arrears, a corporation may not make dividend payments on common shares.
Cumulative
With the exception of convertible preferred stocks, the value of high grade preferred stocks is a function of the ______________s they provide.
Dividend Yield
____________ is a measure of the amount of return earned on annual dividends and is the basis upon which comparative preferred investment opportunities are evaluated.
Dividend Yield
Both maturity and the size of the annual preferred dividend (which is equivalent to a bond's coupon) have a significant effect on the rate of price volatility. That is, a $2 preferred will not appreciate just as much (in percentage terms) as an $8 preferred for a given change in market yields.
F
Firms can deduct preferred dividends as a business expense.
F
Firms that miss preferred dividend payments generally do not have to make them up before they can pay dividends to common stockholders.
F
Normally, the lower the fixed charge coverage, the greater the margin of safety.
F
Preferred Stocks have not proved to be satisfactory long term hedges against ___________.
Inflation
Like many other fixed income securities, _____________ values go down when rates go up.
Preferred Stock
Annual Dividend Income / Prevailing Market Yield = ?
Price of a Preferred Stock
Not all stocks labeled as "preferred" pay dividends; in fact, ___________s pay interest.
Trust Preferred Stock
Traditional preferred stocks, whose dividends are eligible for the 15% (or lower) tax rate, carry a big advantage over ___________, whose income is taxed at ordinary income rates.
Trust Preferred Stock
Even though they hold an ownership position in the firm, preferred stockholders normally have no _____________s.
Voting Right