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Convertible preferred stock is preferred stock that can be converted into common stock as of a predetermined date at a specified ratio.

For example, ABC Corporation issues convertible preferred stock at $50 each with a conversion ratio of 3. That means a shareholder can convert one preferred share into three common shares.

If the common stock’s price climbed to $16.67 a share – which is $50 divided by 3 – or higher, then converting would be profitable. An investor can then realize an immediate cash profit by converting the preferred stock to common stock and selling it immediately.

Ultimately, the decision to convert preferred stock to common stock depends on the performance of the common stock. Even though it usually does not come with voting rights like common stock, preferred stock has other advantages.

Preferred stockholders are paid dividends before common stockholders. And if a company becomes insolvent or declares bankruptcy, preferred stockholders receive any money that’s available to be paid before common stockholders.

Preferred stock also offers its holders guaranteed dividends on a regular basis, while common stockholders receive dividends when the company’s board of directors decides to issue them. Preferred stock is less volatile than common stock, making preferred stock resemble a fixed-income security.

Most convertible preferred stock is exchanged at the shareholder’s request. There are rare occasions when a provision allows the stock issuer to force conversions.

 

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