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Preferred Stock Paper

In: Business and Management

Submitted By krrish9
Words 5116
Pages 21
The Risks of Preferred Stock Portfolios
SLCG Working Paper 1
Abstract Preferred stocks are a hybrid of debt and equity. In this paper, we examine preferred stocks with an emphasis on the risks of holding portfolios of preferred stocks. We demonstrate that preferred stocks are similar to debt when the issuing company is financially healthy, and become more similar to equity when the company’s financial condition deteriorates. We show that issuers of preferred stocks are heavily concentrated in the financial services industry, a fact that exposes investors who hold a portfolio concentrated in preferred stocks to further risk - industry concentration risk. We illustrate the features of preferred stocks using the Fannie Mae 2008 issuance as a case study.

I.

Characteristics of Preferred Stocks
Preferred stocks are a hybrid of debt and equity and have attributes of both

securities. In an issuing company’s capital structure, they give investors a claim to income and assets before common equity investors but after debt holders. Preferred stocks pay a stream of fixed- or floating-rate payments similar to the coupon payments made on debt and provide no participation in the issuer’s residual gains or any voting rights. However, similar to dividend-paying equity, preferred stocks’ dividend payments are not a mandatory obligation of the issuer. Failure to pay preferred stock dividends does not constitute a default. Historically, most preferred stocks were cumulative, meaning that all previously omitted dividend payments must be fully paid before common stock dividends can be paid. More recently, non-cumulative preferred

© 2010 Securities Litigation and Consulting Group, Inc., 3998 Fair Ridge Drive, Suite 250, Fairfax, VA 22033. www.slcg.com. The authors are Guohua Li, Craig McCann and Edward O’Neal. Dr. Li can be reached at guohuali@slcg.com, Dr. McCann can be…...

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