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. Preference Shares

    Preference shares are company stock with dividends that are paid ...
  4. Current Dividend Preference

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

    Noncumulative, as opposed to cumulative, refers to a type of ...
  6. Conversion Ratio

    The conversion ratio is the number of common shares received ...
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. 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.
  3. Investing

    Income Funds 101

    Income funds don't have to be bonds, there are plenty to choose from. Read up on the types of income funds and whether they fit your investment needs.
  4. Investing

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  5. 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.
  6. Investing

    The Top 3 Convertible Bond ETFs for 2016 (CWB, ICVT)

    Obtain detailed information on the exchange-traded funds (ETFs) available for traders seeking ETF exposure to convertible bond investments.
  7. Financial Advisor

    4 Reasons a Company Might Suspend Its Dividend

    Learn about the four most common reasons a company may choose to suspends its dividends, including financial trouble, funding growth and unexpected expenses.
  8. Managing Wealth

    How Will Your Investment Make Money?

    Discover the basic types of investment income and which asset classes pay them.
  9. Investing

    Can a Bond ETF Work in a Rising Rate Environment?

    The CWB Convertible Securities ETF could be the perfect solution for a rising rate environment.
  10. Investing

    Dow Converts Preferred Stock to Common Stock (DOW)

    Dow Chemical CEO Andrew Liveris said Friday's conversion of preferred stock into common stock highlighted the strength of the company's business model.
RELATED FAQS
  1. What is the difference between 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 >>
  3. What are the different types of preference shares?

    Find out four types of preference shares – callable, cumulative, convertible and participatory - and how each benefits you ... Read Answer >>
  4. Do Preferred Shares Offer Companies a Tax Advantage?

    Find out if there is a tax advantage for corporations issuing preferred shares when compared to other forms of financing ... Read Answer >>
Trading Center