CFP

AAA

Characteristics, Uses and Taxation of Investments - Preferred Stocks and ADR



b.
Preferred - nominally an equity security, preferred stock correlates more highly with fixed income in terms of its risk/return profile. Holders of preferred stock are entitled to receive dividends before common stockholders. Additionally, it holds a prior claim to corporate assets in the event of a corporate dissolution. Preferred stock has no voting rights.

There are several types of preferred stock. A brief description of each follows:

  1. Straight Preferred - pays the stated dividend only. There are no special features associated with it.
  2. Cumulative Preferred - holders are entitled to any past dividend payments missed due to financial difficulties that caused the board of directors to suspend them. Dividend arrearages are paid in full before holders of common receive any dividends.
  3. Convertible Preferred - holders have the right to convert shares into common stock of the issuer. Because it offers the conversion privilege, the issuer's preferred stock carries a lower dividend rate than non-convertible preferred with similar terms. As with convertible bonds, the conversion feature, if exercised, is dilutive, decreasing earnings per common share.
  4. Participating Preferred - such shares participate in the issuer's corporate profits after all dividends and interest are paid on other securities in the issuer's capital structure.
  5. Callable Preferred - the issuer has the right to redeem shares in exchange for those with a lower dividend payment. As with callable debt, the issuer benefits from the refinancing. In consequence, this type of preferred has the highest dividend rate, ceteris paribus.

c. American Depository Receipts (ADRs) - issued by foreign branches of large American banks, ADRs enable trading of foreign equities in the United States. They are a negotiable security that represents shares of foreign securities. A custodial bank in the issuer's country holds the actual shares of the stock represented by the ADR. ADRs have voting, but not preemptive rights which the custodian bank sells, distributing the sales proceeds to the shareholders on a pro rata basis. American Depository Receipts are subject to currency risk. Dividends are declared in the foreign currency, but payable in US dollars.
Pooled and Managed Investments
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