KWAME NKRUMAH UNIVERSITY
OF SCIENCE & TECHNOLOGY
COLLEGE OF HUMANITIES & SOCIAL SCIENCE
(SCHOOL OF BUSINESS)
CORPORATE FINANCIAL STRATEGY
(ACF 683)
LAWRENCE YEBOAH
PG9157219
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Preferred stock is a form of stock which may have any combination of features not possessed by
common stock including properties of both an equity and debt instrument, and is generally
considered a hybrid instrument. Preferred stocks are senior in ranking to common stock but
subordinate to bonds in terms of claim or rights to their share of the assets of the company. They
may also have priority over common stock in payment of dividends and upon liquidation.
Preferred stock is referred to hybrid security or fixed-rate capital securities which was introduced in
1993. It is called hybrid security because preferred stock has similarities to both common stock and
bonds. Preferred shares bear characteristics of both common stock and the debt represented by
bonds.
Preferred stock, common stock and bonds are three ways to invest in companies. Common stock
represents owning part of a company and often betting on its growth, while bonds and preferred
stock are more about getting steady, reliable rates of return. Bonds and preferred stock are more
attractive as overall interest rates go down. Many investors like to own some of all three to diversify
their portfolios.
Preferred stock is said to be a hybrid security because it has combined characteristics of common
stocks (equity securities) and bonds (debt securities). It can be juxtaposed in the following
underpinned points:
Bond features in Preferred stock
A good case can be made that preferred stock is really debt in disguise, a kind of equity preferred
bond. Economists state that preferred stock shares are as much like bonds as like common stock
shares. The reason for this comparison is that both preferred stock and bonds have a number of
similarities. For example, both types of certificates are rated by the major credit agencies and both
preferred stocks and corporate bonds retain seniority over common stock in the event the company
liquidates. In addition, the two have several other features in common that make the investments
attractive to investors which is discussed below.
a. Regular Payment
Preferred stocks offer a regular payment of a certain percentage of dividend which is actually a
feature of a bond (debt instrument). In case of liquidation, preference shareholders receive a stated
value. The same case applies to bondholders who receive their principal in case of liquidation. In
fact, preferred stock functions similarly to bonds since with preferred shares, investors are usually
guaranteed a fixed dividend in perpetuity.
b. Value
Like bonds, shares of preferred stock are issued with a set face value, referred to as par value. Par
value is used to calculate dividend payments and is unrelated to preferred stock’s trading share
price. Both have a potential to increase in market value over time, but neither preferred stock nor
bonds increase much in comparison to common stock shares. Both preferred stock and bonds
produce earnings and earn fixed payments: Bonds earn interest and preferred stocks earn dividends.
c. Callable
Both preferred stock shares and bonds may have a call provision. When bonds or preferred stocks
are said to be callable, this means the issuer can force the shareholder or bondholder to redeem the
certificate. In stock or bond certificates with the call feature, the first eligible date the certificates
can be called will be set at the time of issue, after which the issuer can exercise this provision. A
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company may call a bond issue when market interest rates fall to take advantage of issuing new debt
at lower rates.
d. Convertible
Both preferred stock and corporate bonds can be convertible, meaning the certificates include an
option to be converted to shares of common stock. Generally, the price at which preferred stock can
be converted to shares of common stock is set when the preferred are issued. Some bond
indentures, the contract that accompanies the issue, contain a provision allowing the bondholder to
convert the certificate to a set number of shares of the company's common stock. This convertible
feature on bonds is generally set so that the company's stock price must increase significantly before
the bondholder would wish to convert. For example, Enron Corporation issued a preferred stock
which stipulated that one preferred could be converted to three shares of comm0on, at the option
of preferred stakeholder.
e. Maturity
Preferred stocks are also like bonds in that you will get your initial investments back if you hold them
until maturity. Some preferred stock is similar to perpetual bonds in that they have no maturity date,
but most new issues now have specified maturities. For example, many preferred shares have a
sinking fund provision which calls for the retirement of 2 percent of the issue each year, meaning
that the issue will mature in a maximum of 50 years. Also, many preferred issues are callable by the
issue corporation, which can also limit the life of the preferred.
Common stock features in Preferred stocks:
In terms of ownership, preferred stock represents a tiny portion of ownership in a company, like a
common stock does. Preference stocks bears some characteristics of common stock in the following
sense:
a) Ownership
Common stock and preferred stock both give the holders ownership of a company. Preferred stock
ownership occurs when an investor purchases ownership in a public company. Accountants classify
preferred stock as equity; hence it appears as equity account on the balance sheet. In finance, it lies
between debt and common equity as it imposes a fixed charge and thus a financial leverage.
(Frimpong, 2021)
b) Dividend
Preferred stocks pay a dividend like common stock. The difference is that preferred stocks pay an
agreed-upon dividend at regular intervals. This quality is similar to that of bonds. Common stocks
may pay dividends depending on how profitable the company is. Preferred stock dividends are often
higher than common stock dividends. The dividend can be adjustable and vary with the London
Inter-bank Offered Rate, or it can be a fixed amount that never varies.
c) Returns
The price of a share of both preferred and common stock varies with the earnings of the company.
Both trade through brokerage firms. Bond prices, on the other hand, vary with the company's ability
to pay, as rated by Standard & Poor's.
As discussed above, hybrid securities are investment instruments that combine the features of pure
equities and pure bonds. However, these securities tend to offer a higher return than pure fixed
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income securities such as bonds but a lower return than pure variable income securities such as
equities. They are considered less risky than pure variable income securities such as equities but
more risky than pure fixed income securities.
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REFERNCES:
 Frimpong, J., 2021. Corporate Financial Strategy. 6th ed. KNUST- Ayeduase Gate: Graduate
Standards Secretarial Services, pp.132-135.
 Benge, V., 2017. How Is Preferred Stock Similar to Bonds? [Blog] Pocketsense, Available at:
<https://pocketsense.com/preferred-stock-similar-bonds-5441.html> [Accessed 6 March
2021].
 En.wikipedia.org. 2021. Preferred stock. [online] Available at:
<https://en.wikipedia.org/wiki/Preferred_stock> [Accessed 6 March 2021].
 Bin Sattar, S., 2021. Preferred Stocks - Definition, Types, Hybrid Securities, Advantages, and
Characteristics. [online] The Strategy Watch. Available at:
<https://www.thestrategywatch.com/characteristics-preferredstocks/#:~:text=Preferred%20stock%20is%20said%20to,and%20bonds%20(debt%20securitie
s).&text=Bond%20features%20in%20debt%20stock,a%20bond%20(debt%20instrument).>
[Accessed 6 March 2021].
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