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Finance: What is Adjustable Rate Preferred Stock? 15 Views
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What is Adjustable Rate Preferred Stock? Adjustable rate preferred stocks pay dividends that are based on interest rates. Usually these are the rates of government T-bills. They’re a little safer for this reason than traditional preferred stock.
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Transcript
- 00:00
Find it a la shma What is adjustable rate preferred
- 00:06
stock Okay let's start with the basics preferred stock and
- 00:11
yes we have a whole video on this one as
- 00:12
well Preferred stock generally pays a dividend and is often
- 00:17
convertible into common stock at a premium to where it
Full Transcript
- 00:21
was issued So preferred stock is kind of bond like
- 00:26
and kind of equity Like fish Most preferred stocks get
- 00:30
issued some set dividend like a base rate of say
- 00:33
six percent or something like that And note that it's
- 00:36
called a dividend in the case of preferred stock not
- 00:41
an interest payment subtle but very important difference here because
- 00:45
interest on bonds is tax as ordinary income and dividends
- 00:49
on equities are qualified meaning that their tax at long
- 00:54
term gains rates or dividend tax rates anyway these preferred
- 00:58
pay six percent no matter what the price at which
- 01:02
one preferred unit trades will fluctuate like a stock or
- 01:06
bond But that thousand dollars par preferred will just continue
- 01:11
to pay its sixty bucks a year in dividends until
- 01:14
the preferred shares are bought back by the company you
- 01:17
know at some premium or until the shares convert into
- 01:20
being common stock or the company goes bankrupt in armageddon
- 01:24
scenario one starring ben affleck jr But in the case
- 01:28
of adjustable rate preferreds it's not always the six percent
- 01:32
that gets paid or whatever the initially stated rate wass
- 01:36
in the case of these equities and yes preferred stocks
- 01:39
considered equity even though it acts like a bond Sometimes
- 01:42
in this case the dividends will very with some set
- 01:45
indexed like t bills or live or where the preferred
- 01:50
dividend might be set on a say a trailing four
- 01:53
quarter bases to be two hundred basis points Mohr interest
- 01:58
that it pays than the average t bill reign as
- 02:02
of blah blah blah blah time frame Well why would
- 02:05
you want this adjustable feature with preferreds Well you can
- 02:09
imagine a scenario in a low interest rate environment where
- 02:13
we have preferred stocks paying five percent and the prevailing
- 02:16
rates are three percent for very high quality dead teo
- 02:20
top notch blue chip companies But then we get inflation
- 02:25
and that three percent for the best borrowers goes to
- 02:28
six percent and a given preferred stock would then need
- 02:32
to pay more like eight percent to be trading around
- 02:35
The thousand dollars par value it was issued at So
- 02:38
said another way if that piece of paper is on
- 02:41
ly giving investors fifty bucks a year when a very
- 02:45
similar piece of paper gives investors eighty bucks a year
- 02:49
investors will want charity They will sell down than thousand
- 02:54
dollar piece of paper giving only fifty bucks to price
- 02:57
low And so that when it's bought it pays eighty
- 03:02
bucks a year in charity right that thousand dollars going
- 03:05
to sell down to nine hundred eight hundred seven hundred
- 03:08
until whatever you pay for it pay the same interest
- 03:10
rate is that eighty dollars year thing Thank you Inflation
- 03:13
specifically In this case a thousand dollars preferred paying fifty
- 03:17
bucks a year would have to sell for six hundred
- 03:21
twenty five bucks teo yield eight percent meaning that the
- 03:26
thousand dollars par value that investors bought in a five
- 03:29
to ten years ago would drop dramatically by three hundred
- 03:32
seventy five dollars a unit to be six hundred twenty
- 03:36
five dollars To be quote at market unquote and that's
- 03:40
a problem a big risk that investors will hate Hence
- 03:44
the invention of the adjustable feature here Adjustable rate preferred
- 03:49
Stock Great inventions So in this case if it preferred
- 03:53
was adjustable if rates went up a cz were describing
- 03:56
here then it is extremely likely that the t bill
- 04:00
or live or rates would go up similarly as they
- 04:03
generally follow inflation grids over time And in this scenario
- 04:08
if the rate of the dividend on the preferred stock
- 04:11
at just's then it's always going to be something like
- 04:15
t bill ray plus three hundred basis points or something
- 04:18
like that so that if there really is big inflation
- 04:22
and federal funds rates go from three percent to six
- 04:25
percent The return on these preferreds would go up about
- 04:29
the same amount making the security much more appealing to
- 04:33
investors Got all that well let's Just hope that if
- 04:36
anything else is in need of getting adjusted those investors
- 04:39
will take care of it in private nia do that
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