What is 'Convertible Adjustable Preferred Stock (CAPS)'

Convertible Adjustable Preferred Stock (CAPS) is a preferred, floating rate issue whose interest rate is tied to Treasury security rates. CAPS can be exchanged for common stock or cash after the next period's dividend rates are announced. The shares received upon conversion are equal in market value to the par value of the preferred. The dividend payout is set at a base rate plus a benchmark interest rate and resets at specified points in time. Shares are convertible into shares of common stock at a price set when the preferred stock is issued. CAPS protect an investor's principle while also allowing them to participate in upswings in share price.

Breaking Down 'Convertible Adjustable Preferred Stock (CAPS)'

Corporations issue preferred stock as a means of adding equity to their balance sheet or in the belief the cost of capital will be lower than issuing debt. Investors are promised a preferred dividend that must be paid before a corporation is allowed to pay dividends on the common stock. Analysis of any offering should include the corporation's credit rating and the availability of funds to pay the dividend. CAPS, a hybrid form of preferred stock, are special as they add two features to entice investment in the security.

Convertible Adjustable Preferred Stock: Convertibility

The convertibility rules are set when the preferred stock is initially issued. A CAPS initially priced at $100 per share might be convertible into four shares of common stock with a basis of $25 per share. If the common price rises to $30, the conversion profit is $20, or 20%. The price of the preferred shares increases to reflect the potential profit. Investors can choose to sell the preferred shares, convert to common shares or keep collecting dividends. Corporations offer convertibility hoping the potential for capital gains allows for a lower dividend payment.

Convertible Adjustable Preferred Stock: Adjustability

The dividend and how it is adjusted is laid out in the offering documents at the time of issuance. The dividends are a set percentage added to a major benchmark interest rate. The most common benchmarks are the LIBOR, short-term U.S. Treasury bills or U.S. Treasury notes.

A $100 par value CAPS might have a base annual payment of 4% plus the rate of a Treasury note paying 1%, which makes the total payment 5%, or $5. If the Treasury rate rises to 2%, the total payout increases to $6, or 6%.

The adjustment feature stabilizes the market price of CAPS shares, protecting investors from the potential capital loss associated with standard fixed-income securities in a rising interest rate environment. Share values are still susceptible to fluctuation based on changes to the issuing corporation’s credit rating.

Convertible Adjustable Preferred Stock: Taxation

Shares of preferred offerings are attractive to high-income investors because dividends are taxed at a lower rate than interest income. The top tax rate on interest income is 37% on interest income, while dividends are taxed at a top rate of 20%. Investors in lower marginal tax rates also receive substantial tax breaks on dividend income.

RELATED TERMS
  1. Convertible Preferred Stock

    Convertible preferred stock includes an option for the holder ...
  2. Preferred Stock

    Preferred stock refers to a class of ownership that has a higher ...
  3. Current Dividend Preference

    A safety feature that is offered to a company's preferred shareholders, ...
  4. Noncumulative

    Noncumulative, as opposed to cumulative, refers to a type of ...
  5. Dividend Enhanced Convertible Stock ...

    Dividend Enhanced Convertible Stock is a preferred stock that ...
  6. Participating Preferred Stock

    Participating preferred stock gives the holder the right to earn ...
Related Articles
  1. Investing

    Understanding Preferred Stocks

    Companies choose preferred stock for many reasons some being the flexibility of payments and easier to market. Learn the pros and cons of preferred stocks.
  2. Investing

    Introduction to Convertible Preferred Shares

    These securities offer an answer for investors who want the profit potential of stocks but not the risk.
  3. Managing Wealth

    What You Need To Know About Preferred Stock

    Curious about preferred shares? Here's what you should know about these bond-like instruments.
  4. Investing

    Investing in Preferred Stock:The Basics

    Preferred stocks provide income as well as the potential to appreciate in value.
  5. Managing Wealth

    Taking The Bite Out Of A Bear Market

    Find out which financial instruments will protect you from bear market volatility.
  6. Investing

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    LACFX,FACVX,VCVSX: Learn about three of the highest-yielding options available.
  7. Managing Wealth

    The Mandatory Convertible: A "Must Have" For Your Portfolio?

    Mandatory convertibles are a little understood security with some distinct advantages. Find out if they are right for you.
  8. Investing

    The Top 6 Convertible Bond Funds for 2016

    Take a look at convertible bond mutual funds that are well-positioned heading into 2016, and why investors might consider a convertible fund portfolio.
RELATED FAQS
  1. Preference and Ordinary Shares

    Preferred shareholders have a higher priority claim to the assets of a corporation in case of insolvency than common shareholders. Read Answer >>
  2. Why would a company issue preference shares instead of common shares?

    Learn about some reasons that corporations might issue preference or preferred shares, and why investors might value them ... Read Answer >>
Trading Center