SIE Ready🧾 Equity Securities · Lesson 2 of 5 · 6 min
Preferred Stock: The Fixed-Dividend Hybrid
💵 Preferred stock is equity that behaves a lot like a bond: a stated dividend, a price that moves with interest rates, and a place in line ahead of common.
💡 Key idea
Preferred is paid before common (dividends and liquidation) but after every creditor. Cumulative arrears must be paid in full before common gets a dividend.
🧠 Why it matters
Preferred stock pays a stated dividend (a % of par, usually $100 par) that must be paid before any common dividend, and it ranks ahead of common, behind all creditors, in a liquidation. Voting is usually limited or absent. CUMULATIVE: missed dividends pile up in arrears and must all be paid before common gets anything. PARTICIPATING: may receive extra dividends above the stated rate. CONVERTIBLE: exchangeable into a set number of common shares (par ÷ conversion price); parity means the two values are equal. Converts usually pay a lower dividend. CALLABLE: the issuer can buy it back at a set price, so it usually pays more. ADJUSTABLE-RATE: the dividend resets with a benchmark rate, keeping the price steadier. Fixed-rate preferred prices fall when rates rise.
📈 In the real world
🧮 Marco owns 6% cumulative preferred, $100 par, in Ridgeline Rail. The company skipped dividends for 2 years, then recovered. Before common holders see a cent, Ridgeline must pay Marco $6 × 2 years in arrears + $6 for this year = $18 per share. His colleague's noncumulative preferred gets only this year's $6.
📌 Takeaways
- Stated dividend = rate × par ($100 par, 6% = $6 a year)
- Cumulative: arrears + current year before any common dividend
- Convertible pays less, callable pays more, adjustable-rate holds its price best
📖 Terms in this lesson
Preferred stock: Equity with a stated dividend paid before common dividends and a claim ahead of common stock in liquidation, usually without voting rights.
Cumulative preferred: Preferred stock whose missed dividends pile up and must be paid before common shareholders receive any dividend.
Convertible preferred: Preferred stock the holder may exchange for a set number of common shares.
CUMULATIVE ACCUMULATES: Missed dividends on cumulative preferred accumulate and must be paid before any common dividend.
✅ Test yourself
A 5% cumulative preferred, $100 par, missed last year's dividend. How much per share must be paid before common holders receive a dividend this year?
- $5
- $10
- $15
- $100
Answer: B · $10
$5 per year × (1 year in arrears + this year) = $10. $5 ignores the arrears, $15 counts a year that was not missed, and $100 is par, not a dividend.
Which type of preferred stock usually has the most stable market price when interest rates change?
- Adjustable-rate preferred
- Cumulative preferred
- Participating preferred
- Callable preferred
Answer: A · Adjustable-rate preferred
An adjustable-rate preferred's dividend resets with a benchmark rate, so its price stays closer to par. The other types pay a fixed stated rate, so their prices fall when rates rise.
A convertible preferred has $100 par and a conversion price of $20. How many common shares does each preferred share convert into?
- 5 shares
- 10 shares
- 20 shares
- 2 shares
Answer: A · 5 shares
Conversion ratio = par ÷ conversion price = $100 ÷ $20 = 5 shares. 20 confuses the price with the ratio; 2 and 10 come from wrong division.
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