CHAPTER 18 Lecture Preferred Stocks and Convertible Securities

CHAPTER 18, Lecture Preferred Stocks and Convertible Securities Chapter Sections: Bond Indentures (pages 564 to 568) Bond-to-Stock Conversion Provisions Graphical Analysis of Convertible Bond Prices Preferred Stock (pages 574 to 575) Adjustable-Rate Bonds & Adjustable-Rate Preferred Stock 1

2 What are Preferred Stocks? n Stocks that have a prior claim (ahead of common stocks) on the income and assets of the issuing firm w a. k. a. Hybrid Securities, Fixed-income Stocks w Preferred Stocks pay a fixed dividend § Percentage of “par value” § In much the same way as a bond pays a fixed interest amount w Preferred Stocks represent equity § Therefore, doesn’t count as debt on the corporate balance sheet In case of corporate default, preferred stocks have priority over common stockholders but are subordinate to bonds.

3 Preferred Stock n Advantages w Highly predictable income stream w Excellent record of meeting dividend payments w Some tax benefits if owned by another corporation n Disadvantages w Susceptibility to inflation § Much like bonds w Dividends can be suspended or postponed § Unlike bonds, which must pay interest or risk default w Lack potential of substantial capital gains § Unlike common stock w Normally, do not pay as well as bonds

4 Convertible Securities n Fixed-income obligations that can be converted into a specified number of shares of the issuing company’s common stock w Convertible bonds and convertible preferred stock w a. k. a. Deferred Equity w “Equity kicker” – ability to share in the possible appreciation of common stock w Example: § $1, 000 bond, convertible to 20 shares of common stock $1, 000 bond 20 shares of stock

5 Convertible Price Behavior

6 Convertible Securities n Bottom Line on Convertibles? w Convertible securities allow you to partake in the potential capital appreciation of the common stock w With less risk because of the income from the convertible bond or convertible preferred stock § If the stock price is below the conversion price, then the convertible security’s price will be kept up because of its value from producing income (bond or preferred stock) Hybrid securities. Some folks say they are the best of both worlds. Some folks say they are the worst of both worlds. Personally, I’ve only met one guy who invested in them and he wasn’t too happy about their performance…

CHAPTER 18 – REVIEW 7 Preferred Stocks and Convertible Securities Chapter Sections: Bond Indentures (pages 564 to 568) Bond-to-Stock Conversion Provisions Graphical Analysis of Convertible Bond Prices Preferred Stock (pages 574 to 575) Adjustable-Rate Bonds & Adjustable-Rate Preferred Stock Next: Exam 4 on Bonds, Bond Prices, and Convertible Securities