Preferred stock occupies a middle position in the capital structure — above common stock but below debt securities. It combines features of both stocks and bonds: it represents equity ownership yet pays a fixed (or adjustable) dividend expressed as a percentage of par value or a stated dollar amount. Because of the fixed dividend, preferred stock price behavior is more sensitive to interest rate changes than common stock.
The four primary types are cumulative preferred (missed dividends accumulate as dividends in arrears and must be paid before any common dividend), non-cumulative preferred (missed dividends are gone forever), participating preferred (may share in additional dividends beyond the stated rate), and convertible preferred (can be converted into a set number of common shares at the holder's option).
Callable preferred allows the issuer to redeem shares at a set call price, typically at a premium to par, after a specified date. This creates call risk for the investor — the stock may be called away in a falling rate environment when income is most valuable.
In liquidation, preferred shareholders are paid before common shareholders but after all creditors. Preferred stock typically does not carry voting rights, though some issues grant conditional voting rights if dividends are skipped for a certain period.
> Exam tip: On the Series 7 and Series 65/66, be prepared to distinguish among the types of preferred. Cumulative preferred is the most investor-friendly because unpaid dividends accrue. Remember that preferred dividends are paid from after-tax corporate earnings (not deductible), while bond interest is a pre-tax corporate expense — a key contrast for the CFP and Series 65 exams.