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In what respect is preferred stock similar to bonds, and in what respect is it similar...

In what respect is preferred stock similar to bonds, and in what respect is it similar to common stock? Please use examples to better demonstrate your explanations. I need the examples

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Expert Solution

Preferred Stock is a category and type of ownership of a company which ranks above common stock and just below debt in its claim over the company's earnings and assets. This essentially implies that company's net income is first apportioned among debtholders, followed by the preferred stockholder and then finally the common stockholder.

A preferred stock is similar to debt in the sense that it pays a constant stream of income to its holders in the form of an annual dividend. This dividend could be fixed, based on a reference rate (such as the LIBOR), etc. The dividend is always calculated as a fixed or stated % of the preferred stock's par value which is similar to bond's periodic coupon payment calculations. Further, as preferred stock dividends are fixed (or based on benchmark which is fixed), their prices behave more like bonds (fixed income security) and less like common stock.

A point of similarity between common stock and preferred stock is that both represent a form of partial claim on the firm through a kind of equity ownership. The common stockholders, however, have voting rights, variable dividends but priority lower than preferred stockholders with respect to claim on the company's earnings and assets.


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