Understanding How Preferred Stocks are Traded

Preferred stocks or preferred securities are a form of investment that blends characteristics of both stocks and bonds. They offer investors a unique set of benefits and considerations when it comes to trading and investment.

What are Preferred Stocks?

Preferred stocks are hybrid investments that pay dividends to investors before common stockholders. These securities also come with preferential rights in terms of earnings and asset distribution. However, as part of this benefit, preferred stockholders do not possess the voting rights in a company that common stockholders have.

Trading of Preferred Stocks

Preferred stocks are traded on the same exchanges as common stock, but their issuance is relatively rare. Companies do not typically issue preferred stocks, making this market smaller and resulting in limited liquidity. The price of preferred shares is determined by a variety of factors, including the dividend rate, the creditworthiness of the company, and the type of preferred share, whether it is cumulative, convertible, etc.

Inverse Relationship with Interest Rates

Share prices of preferred stocks have an inverse relationship with interest rates. When interest rates rise, the value of preferred stocks typically decreases, and vice versa. This relationship is due to the preference shares' characteristics similar to fixed-income instruments like bonds.

Callable Preferred Stocks

Many preferred stocks are callable. This means that the issuer has the right to redeem the stocks at a set price, usually the par value, before the stated maturity date. Like bonds, preferred stocks often carry a credit rating from a recognized rating agency. Generally, these ratings are a little lower than the issuing firm's individual bond ratings.

Trading on the Secondary Market

Preferred stocks can be traded on the secondary market just like common stock. However, the ease of transaction does not guarantee that you will receive the preferred prices. While preferred stock prices are more stable than common stock prices, they do not always match par values.

Limitations and Considerations

Despite the benefits of preferred stocks, there are limitations and considerations one must take into account. Smaller and less liquid markets mean that price stability is not always guaranteed, and trading may be more challenging. Additionally, the ability for the company to redeem the preferred stock at a set price means that there might be limitations on the long-term investment potential.

Conclusion

Preferred stocks are a unique type of investment that fall between stocks and bonds. They offer specific benefits such as preferential dividend payments and asset distribution rights. While they can be traded on the same exchanges as common stock, they face challenges due to limited issuance and smaller, less liquid markets. Understanding these factors is crucial for investors considering this type of investment.

Keywords

preferred stocks, trading, securities