Introduction
Preferred stock is a type of equity security that offers investors certain advantages over common stock, such as dividend preference and priority in liquidation. Understanding these features is critical for anyone preparing for the FINRA Series 7 exam, as it will be essential when advising clients on investment products. This section will explore the unique attributes of preferred stock and provide quizzes to enhance your learning.
Dividend Preference
Preferred shareholders enjoy dividend priority over common shareholders, meaning they are paid before any dividends are given to common stockholders. These dividends are usually fixed, providing a stable income stream for investors. This feature makes preferred stock attractive to income-focused investors.
Priority in Liquidation
In the unfortunate event of company liquidation, preferred shareholders have a higher claim on the company’s assets than common shareholders, although they are behind debt holders. This priority increases the security of their investment, as it offers a better chance of recovery if the company goes under.
Lack of Voting Rights
Unlike common shareholders, preferred stockholders usually do not have voting rights. However, certain circumstances, like missed dividend payments, may trigger voting rights for preferred shareholders. This lack of control over company decisions can be a drawback for some investors.
Conclusion
Preferred stock represents a hybrid form of equity that offers advantages such as dividend preference and liquidation priority, but typically at the cost of voting rights. These features are vital for candidates preparing for the FINRA Series 7 exam, as they need to understand the intricacies of various investment products.
Glossary
- Dividend Preference: Priority given to preferred shareholders to receive dividends before common shareholders.
- Priority in Liquidation: The order of claims on company assets in case of liquidation.
- Voting Rights: The ability to vote on corporate policy, often lacking in preferred stock.
Additional Resources
- FINRA’s Preferred Stock Guide
- Investment Product Strategies for Series 7
- Equity Securities: A Comprehensive Study
Quiz Section
Test your understanding of the features of preferred stock with these quizzes:
### What is one advantage of preferred stock over common stock?
- [x] Dividend preference
- [ ] Higher voting rights
- [ ] More significant capital gains potential
- [ ] Greater market price stability
> **Explanation:** Preferred stockholders receive dividends before common stockholders, ensuring a stable income stream.
### In the event of liquidation, who has priority?
- [x] Debt holders
- [ ] Common shareholders
- [ ] Preferred shareholders
- [x] Government tax claims
> **Explanation:** Debt holders and government claims are prioritized over preferred shareholders in liquidation.
### Do preferred shareholders typically have voting rights?
- [ ] Yes, always
- [x] No, unless specified under certain conditions
- [ ] Only in small companies
- [ ] Yes, for major decisions only
> **Explanation:** Preferred shareholders generally do not have voting rights unless the company misses dividend payments or under specified conditions.
### What is fixed in preferred stock dividends?
- [x] Amount
- [ ] Frequency
- [ ] Payment date
- [ ] Method of payment
> **Explanation:** Preferred stock dividends are typically a fixed amount, providing reliable income.
### Which investors are most attracted to preferred stock?
- [x] Income-focused investors
- [ ] Growth-focused investors
- [x] Risk-averse investors
- [ ] Speculative traders
> **Explanation:** Income-focused and risk-averse investors appreciate the fixed dividends and stability of preferred stock.
### Preferred stock is a hybrid between which two securities?
- [x] Equity and debt
- [ ] Equity and real estate
- [ ] Debt and derivatives
- [ ] Commodities and equity
> **Explanation:** Preferred stock combines features of both equity (like stock ownership) and debt (like fixed income).
### What happens if a company skips a preferred dividend?
- [ ] Nothing, it's forfeited
- [ ] Common shareholders pay it
- [x] It accumulates (cumulative preferred stock)
- [ ] The company goes into liquidation
> **Explanation:** For cumulative preferred stock, unpaid dividends accumulate and must be paid before any common dividends.
### Which of the following is NOT a feature of preferred stock?
- [x] Voting rights
- [ ] Dividend preference
- [ ] Liquidation priority
- [ ] Fixed dividends
> **Explanation:** Voting rights are generally not included with preferred stock, except under certain conditions.
### True or False: Preferred stock can convert into common stock.
- [x] True
- [ ] False
> **Explanation:** Convertible preferred stock can be converted into a specified number of common shares.
### In which scenario might preferred shareholders gain voting rights?
- [x] If dividends are missed
- [ ] During the annual meeting
- [ ] If stock price drops
- [ ] When the CEO resigns
> **Explanation:** If dividends are missed, preferred shareholders may temporarily gain voting rights.