FIN 3715 Chapter Notes - Chapter 8: Preferred Stock, Stock Valuation, Hybrid Security
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The Valuation and Characteristics of Stocks
8.1 Preferred Stock
It is a hybrid security with features of common stock and bonds. Like common stock it has no
fixed maturity date, non-payment cannot bring on bankruptcy, and dividends are not deductible
for tax purposes. Like preferred stock, the dividends are limited in amount.
Characteristics of Preferred Stock
1. Multiple Series: Firms can issue preferred stock in different series, differentiated on the
basis of convertibility, and varying degrees of bankruptcy protection.
2. Claim on Assets and Income: In case of bankruptcy, preferred stock has priority over
common stock, and is therefore less risky. However, it’s still more risky than long-term
3. Cumulative Dividends: All unpaid preferred stock dividends are paid before common
stock dividends are paid.
4. Protective Provisions: There entail the preferred stockholder to voting rights in case of
dividend non-payment, or if there firm is in any financial difficulty.
5. Convertibility: At the discretion of the owner, the stock can be converted into
predetermined number of shares of common stock.
6. Retirement Provisions: A company can repurchase its preferred stock over a given period,
at preset prices.
8.2 Valuing Preferred Stock
The preferred stockholder receives a fixed dividend in each period.
Calculating the present value
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