Preferred stock

Definition: A special type of stock that corporations may issue to raise money. It differs substantially from common stock in that:

* it has no voting rights
* it is entitled to a fixed (ie, unchanging) dividend, not one that may increase from year to year as may be the case for common stock
* it may have a cumulative feature, entitling holders to “catch up” dividends if the Board of Directors decides to skip paying them for one or more quarters.

Each share is normally issued for $100 (ie, its par value) and the amount the holder is to be paid is expressed as a percentage of that value. See our example below.

Should the company go out of business in a process called liquidation, preferred shareholders get in line after bondholders but in front of common shareholders. This makes it “senior” to common stock.Example: On September 23, 2008, a time when the financial crisis was raging, Berkshire Hathaway helped calm fears about the stability of banks by purchasing $5 billion of preferred stock of investment bank Goldman Sachs. This stock pays 10% per year, meaning that for each $100 share it bought from Goldman, it will be paid an annual dividend of $100 x 10%, or $10.

Investeach explains: Because preferred stock has some of the features of common stock (eg: its term never ends) and some of the features of bonds (ie, the holder receives a fixed, unchanging payment each year), it is often called a “hybrid” security.

Because the fixed payment is essentially all holders are entitled to, preferred stock trades like a bond. That is, its market value is influenced by the same thing bond prices are, namely current interest rates.

Riddle me this:

1. Why is preferred stock considered senior to common stock?
2. In what way is preferred stock like common stock?
3. In what way is preferred stock like a bond?
4. Having characteristics of common stock and bonds is the reason why preferred stock is known as what type of security?
5. What has the most significant influence on the market value of preferred stock?
6. What is the term we use to describe the process of a company going out of business?