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Preferred Stock

Preferred stock, also known as preferred shares refers to equity securities with the features of both equities and debts. They are generally rated higher than common stock but lower than bonds. Given below are top questions about stocks that have been answered by the Experts.

What is the similarity between a preferred stock and debt?

Preferred stock pays a fixed amount to people in the form of a dividend similar to the interest that is paid on debt. This is how preferred stock and debt are similar.

How is the required return calculated on preferred stock?

The formula for calculating required return on preferred shares is dividend/market price.

What is the formula for calculating the cost of preferred stock if one knows the dividend, sale price and flotation cost?

If one knows the dividend amount, sale price and floatation cost, then the formula for calculating the price of the preferred stock would be dividend/sale price minus floatation cost.

Are preferred stock and common stock different?

A preferred stock is generally ranked higher than the common stock. Its terms are decided between the investor and the corporation. Common stock, on the other hand is a type of security. It is a corporate equity ownership. Preferred stocks and common stocks are different from each other in many ways. Some of the differences are given below:

In most situations, common stock is given to founders and employees of a company through the employee stock option whereas preferred stocks are issued to other investors.

Preferred stock holders may have a bigger claim in the company’s assets. As a result, if a company needs to be liquidated, the common stock holders may not receive anything till all the preferred stock holders have received their share.

Generally, the dividends of preferred stock are greater than common stock and are paid at regular intervals. The dividends of common stock may not be paid at regular intervals as the decisions about paying or not paying these dividends may be taken by the company’s board of directors.

Preferred stocks are in no way dependant on the market and hence are considered as a more stable form of investment in comparison to common stock.

In what way is a perpetual bond similar to preferred shares?

A perpetual bond, like preferred shares, has a fixed rate which is paid to the owner of the bond. Both perpetual bonds and preferred shares get their value from taking the interest or dividends.

Would preferred stocks be considered a good investment option?

Preferred stocks may be considered a good investment option by many people due to its various advantages. Some of these advantages are a bigger claim for the stock holders in the company’s assets and earnings and greater dividends in comparison to common stocks.

What would happen if a cash dividend was declared on a preferred stock?

In most situations, if a cash dividend was declared on preferred stock, the retained earnings would reduce. This in turn would decrease the total stock holder’s equity.

When you put money into preferred stocks, it is your hard earned money that you are parting with. Hence, you need to be sure that you have understood every feature of the stock correctly and are taking an informed decision. Sometimes you may not find it simple to understand the various pros and cons of preferred stocks without professional help. In such situations, you can ask an Expert and get your questions answered before you invest your money into these stocks.
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