Callable Preferred Stock

Callable Preferred Stock
See also


Callable Preferred Stock may be repurchased by the issuer as of a certain date for a certain price. The call generally happens only if interest rates drop. When interest rates go down, the issuer might get tired of paying generous 6% dividends every year. If so, they can buy the preferred stock back and retire the shares. Or replace them with new preferred stock paying lower dividends that reflect the new lower interest rate environment.

Callable preferred stock tends to pay the nicest rate of return. Most types of preferred stock have no maturity date and are, therefore "perpetual". That's why callable preferred stock is unique. Since this type of preferred stock is callable, it can be repurchased and retired by the issuer instead of paying out preferred dividends indefinitely[1].

Most preferred stock

Most preferred stock is callable preferred stock- that is, the issuing corporation can redeem or retire it at a price stated in the preferred stock contract. An owner of nonconvertible preferred stock must surrender it to the issuing corporation when asked to do so. If the preferred stock is convertible, the stockholder can either surrender the stock to the corporation or convert it to common stock when the corporation calls the stock. The call price, or redemption price, is usually higher than the stock's par value. For example, preferred stock that has a $100 par value might be callable at $103 per share.

When preferred stock is called and surrendered, the stockholder is entitled to the following[2]:

  • the par value of the stock
  • the call premium
  • any dividends in arrears
  • the current period's dividend prorated by the proportion of the year to the call date

Redeemable Preferred Stock

In contrast to convertible preferred stock and callable preferred stock, some preferred stock is redeemable. Redeemable preferred stock either may be subject to mandatory redemption at a specified future maturity date for a specified price, or redeemable at the option of the holder (instead of being callable at the option of the issuer).

Redeemable preferred stock has a key characteristic of a liability because of the likelihood of a cash outflow in the future that the company has no ability to prevent. Therefore, a corporation with mandatory redeemable preferred stock is required to report the preferred stock as a liability. If both the maturity date and redemption price are fixed, at the end of each year the corporation reports the liability at the present value of the amount to be paid at settlement.

To determine the present value, the corporation uses the implicit interest rate when it issued the redeemable preferred stock.It records interest expense for the change in the present value during the year. If either the maturity date or the redemption price is not known, at the end of each year the corporation reports the liability at its current market value[3].

Footnotes

  1. R.M. Walker 2010, p.204
  2. B.E. Needles, M. Powers 2010, p.533
  3. L.A. Nikolai, J.D. Bazley 2010, p.810

References

Author: Sylwia Jurkowska