Some investors were compensated for their auction-rate preferred losses as the recession ended.
Wells Fargo agreed to buy back stocks, which were very safe.
The penalties for bidding on auction rate securities in the first quarter of 2008 were up to $1.9 billion.
The holders of preferreds will have a claim on assets if necessary.
Before the claims of the common stock holders can be made, preferred claims must be satisfied.
This obligation doesn't always mean that the full par or stated value of the preferred share will be recovered, because the claims of senior securities must be met first.
This stock has precedence over other preferred stock in its right to receive dividends and in its claim on assets in the event of liquidating.
Before making an investment in a preferred security, investors should be aware of the preferred stock provisions.
The obligation of the issuer is important.
If the stock has a call feature or a sinking-fund provision, investors should be aware of it.
It depends on whether the preferred stock is issued on a cumulative or noncumulative basis.
The preferred dividends must be made up in full before dividends can be paid to common stockholders.
For example, if the firm misses the dividend for three quarters in a row, it will normally pay $1 a quarter on its preferred stock.
The firm has preferred dividends that are in arrears.
It needs to meet past dividends and the next quarterly dividend before it can pay dividends to common shareholders.
The firm could pay $2 per share to preferred stockholders at the next quarterly dividend date and $3 per share at the following one, covering the remaining $2 in arrears and the current $1 quarterly payment.
The firm couldn't make dividends on common stock.
Meeting the next preferred dividend is how it could resume such payments.
The issue is more highly valued if there is a provision.
It has become more popular to issue pre fixed-income investors since the early 1970s.
There are a lot of preferreds carrying this preferred stock investors.
The preferreds become quarterly after the deferral period.
If the market conditions are bad, such issues are vulnerable to be called.
The yields on a floor and a ceiling should be higher than those on noncallable issues.
With plenty of room to move up bonds, the call price of a preferred stock is made up of the par value of the or down with market rates.
It may be as much as 1 year's dividends when issue and call premiums are included.
There's far less price volatility paid off--amortized--over time if all or a part of an issue is line.
Sinking-fund preferreds have implied with different maturities.
Firms use them to reduce the cost of financing.
A typical sinking-fund preferred share requires the firm to retire half the issue over a 10-year period.
The investor has no control over which shares are called.
Many preferred issues today have explicit maturity dates.
When Wall Street began to create trust preferred stocks that could be taxed as debt, these began to appear in the 1990s.
The maturity dates of preferred stocks were usually 30 to 50 years.
Define preferred stock.
Distinguish a cumulative preferred share from a callable preferred share.
Although preferred stocks may be a form of equity, they behave more like bonds than a stock in the market.
It seems logical that preferreds should be valued like bonds, with market interest rates and investment quality playing key roles.
When it comes to investing in preferreds, you would expect interest rates to play a role in preferred stock investment strategies.
The two most widely used preferred stock strategies involve either going after high levels of current income or seeking capital gains when market rates are falling.
Evaluating the investment suitability of preferreds involves looking at return opportunities.
Let's look at some of the return measures that are important to preferred stockholders and the role that agency ratings play in the valuation process.
It is important to determine the price and return behavior of preferred stocks.
The preferred shares have a par value of $100.
The percentage of par value is expressed as the dividend rate.
The shares had a market price of $82.50 in August of 2015.
If the preferred share price goes down to $50 a share, the yield goes up to 7.5%.
The risks and other characteristics of preferred stock are evaluated by investors.
Long-term investors may consider dividend yield a key factor, but it's not always the case with short-term traders.
These traders focus on anticipated price behavior and expected return from buying and selling an issue over a short period of time.
The expected future price of a preferred stock is important to short-term traders.
Predicting future market interest rates can be used to find expected price.
Suppose a preferred stock pays $3 in dividends and is expected to decline in value over the next 3 years.
3 years from now, the issue will have a market price of $50 if the market rates prevail.
The expected return or the holding period return formula would be used to assess the return potential of the investment.
If the stock were priced at $28 a share, it would have an expected return of 30.3% over the 3-year investment horizon.
It is possible to apply it to common stocks in Chapter 8 and bonds in Chapter 11 as a measure of expected return.
The discount rate that equates the expected future cash flows from this preferred stock to its current market price is what you want to find.
The preferred stock has a cash flow of $50 per year for 3 years and annual dividends of $3 per year over the next 3 years.
The discount rate is the rate at which the present value of the future cash flows is.
A financial calculator can be used to solve for the expected return.
The preferred shareholders have a claim on the net assets of the firm.
The book value per share is found by subtracting the firm's assets from its liabilities and dividing the difference by the number of preferred shares outstanding.
This measure shows the quality of an issue with regard to the preferred stock's claim on assets.
A preferred stock with a book value of $150 per share enjoys generous asset support and more than adequately secures a par value of $25 a share.
Net asset value can be used relative to an issue's par value.
As the margin by which book value exceeds par value increases, the quality of an issue improves.
The attention is on the firm's ability to service preferred dividends and live up to the preferred's preferential claim on income.
The quality of a preferred stock is determined by fixed charge coverage.
The preferred dividends are adjusted by a factor.
This adjustment is used with "traditional" preferred stocks and takes into account the fact that a company pays dividends from the earnings that are left after taxes.
A corporate tax rate of 35% is a reasonable rate to use for our purposes here.
By adjusting, preferred dividends are placed on the same basis as interest paid on bonds, which is a tax-deductible expense.
The company is generating just enough earnings to meet its preferred dividends, which is not a good situation.
M17_SMAR3988_13_GE_C16.indd 8 13 May 2016 12:24 PM of 0.7 suggests the potential for some real problems, whereas a coverage of 7.0 indicates that preferred dividends are fairly secure.
The common stock interest coverage ratio states that fixed charge coverage is computed with the numerator rather than the EBIT.
Since earnings before interest, taxes, depreciation, and amortization will usually be more than EBIT, use of EBITDA will result in a higher coverage ratio, something that should be taken into consideration when assessing this measure.
If you're dealing with one of the newer debt-like preferreds, you can drop the adjustment factor because preferred dividends are treated like interest expense.
It will lead to a higher fixed-charge coverage because the denominator will be smaller and other things will be equal.
Since 1973, Standard & Poor's and Moody's have rated the investment quality of preferred stocks.
Moody's and S&P both use the same rating system for bonds.
The higher the rating, the more likely the issuer will be able to pay dividends promptly.
Although preferreds come in a full range of agency ratings, most fall in the medium-grade categories.
The market yield of an issue can be reduced by higher agency ratings.
Agency ratings help investors get a handle on the yield and potential price behavior of an issue and eliminate much of the need for fundamental analysis.
There are several investment strategies preferred stockholders can follow.
Each offers a different level of return and exposure to risk, and is useful in meeting a different investment objective.
This strategy is suited for serious long-term investors and is perhaps the most popular use of preferred stocks.
The procedure involves looking for preferreds with the most attractive yields in order to get high current income.
Features such as the quality of the issue, whether the dividends are cumulative, the existence of any call or sinking-fund provisions, and, of course, whether the divi dend qualifies for the new preferential tax rate are also considered.
Income and safety are important in this strategy because yields are only attractive if dividends are paid.
Some investors only buy the highest-quality preferreds.
Some sacrifice quality in return for higher yields when the economy is strong and use higher quality issues only during times of economic distress.
If you leave one of the top four ratings, you should be aware of the speculative position you are in.
Legal enforcement of preferreds' dividends is lacking.
Most preferreds pay dividends on a quarterly basis.
Special breeds of preferred stocks offer attractive yields and monthly income.
Before investing in these and other specialty securities, you should learn as much as you can about them.
An aggressive short- term trading posture is adopted by the investor who trades on movements in interest rates.
This is done because of capital gains.
High return is possible with this approach, but it comes with higher risk.
The market behavior of investment grade issues is linked to movements in interest rates because they are fixed-income securities.
Capital gains opportunities may be realized from pre ferred stocks if market interest rates decline substantially.
This is what happened after the recession.
In the twelve months starting in March 2009, preferred yields and preferred stock prices fell.
In 2009, preferred shares rose 27%.
It's not uncommon to find preferreds with 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 888-353-1299 During the credit crisis and recession preferred yields rose so preferred share prices fell.
The yield on preferred same principles used with bonds applies to preferred stocks.
For example, stocks have averaged over six percent.
Short-term holding period returns can be magnified by margin trading.
The high leverage rates of bonds are not available with preferreds because they fall under the same, less generous margin requirements as common stocks.
The investment selection process is simplified because neither maturity nor the size of the annual pre ferred dividend has much effect on the rate of price volatility.
For a given change in market yields, a $2 preferred stock will appreciate just as much as an $8 preferred stock.
If you're able to catch a trading opportunity before everyone else, this speculative investment strategy can prove profitable.
The idea is to find preferred stocks whose dividends have gone into arrears and whose rating has plummeted to one of the speculative categories.
The financial problems of the issuer would affect the price of the issue.
There is more to this strategy than just finding a speculative-grade preferred stock.
It is difficult to find a speculative issue whose fortunes are about to change.
This strategy requires a lot of fundamental analysis and is similar to investing in speculative common stock.
The investor is betting that the firm's financial performance will improve and that it will be able to service its preferred dividends in a timely fashion.
It involves a fair amount of risk.
The rewards from high-risk investing are limited.
Capital gains potential is limited to the price level of other A-rated preferreds if a candidate is expected to recover to an A rating.
Although price performance may be somewhat limited, it is still substantial and can easily amount to holding period returns of 50% or more.
Such returns are not out of line because of the risks involved.
The price level of other preferreds of comparable quality and dividends limits capital appreciation and is a type of price cap.
There are hybrid securities that combine debt and equity.
Common stocks have a lower claim on income and assets than preferred stocks.
This means that preferred dividends have to be paid before dividends can be paid to common stockholders.
The dividends provided by preferreds are attractive.
Capital gains can be produced when interest rates decline.
Most preferred stock's dividends do not qualify for the new preferential tax rate.
The price behavior of a preferred stock is related to market interest rates.
The yield is the main reason for holding preferreds.
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Write down how each differs from a conventional preferred stock.
The preferred share has a 9% dividend yield.
If the dividend rate on the stock is adjusted once a year, it will be paying an annual dividend of $5.40 a share.
Due to major changes in the market, it is anticipated that the annual dividends will drop to $4.50 a share on the next adjustment date, which is just around the corner.
The Bullorbear Company has $2 preferred stock.
It has an EBIT of $40 million and has an annual interest payment of $2 million.
If the dividends qualify for the preferential tax rate, determine the fixed charge coverage of the preferred stock.
The fixed charge coverage of this preferred stock is $5.5 million, and the firm also has depreciation and amortization.
The Bullorbear Company has trust preferred stock.
The firm has an annual interest payment of $2 million.
Determine the fixed charge coverage on trust preferred stocks.
100 shares of a preferred stock were purchased for $25 per share a year and a day ago.
You sold the stock for $30 per share.
The stock of a mature com pany that pays annual dividends of $2 is currently trading at $25.
Another investment is a trust preferred stock that pays dividends and is currently trading at $25.
If the dividends qualify for the preferential tax rate, select one of the preferred stocks.
Determine the following by using the resources at your campus or public library.
Sara-J Co. has a preferred stock that pays dividends each year.
If you have a 7.5% required rate of return, use one of the dividend valuation models to price this stock.
Charlene Weaver likes to speculate with preferred stock.
She thinks the market is about to drop in rates.
She is considering investing in a preferred stock that pays $7 in annual dividends and is currently trading at $75 a share.
She doesn't want to change her holdings.
Mr. Michaels told Penni that he thinks the market yield on preferreds like LaRamie should fall to 7% within the next 3 years.
Penni could choose an alternative investment that she is confident can produce 10% earnings over the next 3 years, instead of buying the LaRamie preferred stock.
Market interest rates and investment quality play a major role in the value of preferred stocks.
It is likely that interest rates play a key role in the investment strategies of those interested in preferred stock investing.
The main strategies involve either seeking high levels of dividend income or taking advantage of falling market interest rates.
The following questions are related to preferred stock investments.
The preferred stock had a stated dividend of 8%.
The par value of preferred stock is $75.
The dividends that qualify for the preferential tax rates are paid annually if the firm has 800,000 shares of the preferred stock outstanding.
The EBIT is $85 million and it has annual interest payments of $3 million.
The firm is taxed at a rate of 30%.
A group of speculators are interested in the Scully preferred stock because of the current market interest rates.
The group believes that the future course of rates will lead to an increase in their equity value.
Hecla Mining preferred stock has a regular dividend of $0.875 per quarter.
Hecla preferred shares sold for $57 in December of 2015.
President Bush proposed and Congress passed a series of tax cuts affecting investors, but one of the compromises required to gain passage of the legislation was a provision that the tax cuts would expire on January 1, 2011.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the Bush tax cuts through the end of 2012 because of the need to continue recovery from a deep recession.
You should be able to get $250,000 after studying this chapter.
The top federal income tax rate on dividends and capital gains increased from 15% to 23.8% in just two years.
Tax rates can change over time, so investors are aware of that.
Many investors will continue to benefit from the Bush characteristics of tax shelters if you define tax avoidance and tax deferral.
Explain to taxpayers the basic strategies that investors can use to increase their income.
Define the characteristics of deferred annuities.
The necessities of life include food, clothing, and shelter.
Shelter protects us from the elements.
Without adequate protection, investors' returns can be greatly reduced by taxes.
In making investment decisions, we must take into account the tax effects associated with a given investment strategy.
Investments that provide the maximum after-tax return for a given risk are important because tax effects depend on one's tax brackets.
Some of the changes are automatic.
The income levels that define the tax brackets are adjusted for inflation.
The tax code is implemented by Congress.
Legislative changes are not finalized until late in the year.
Although tax rates and other provisions can change, the basic principles involved in tax planning will remain the same.
Review the current regulations, IRS publications, and other tax preparation guides when doing your own tax planning.
The federal income tax law imposes a higher tax burden on higher income.
A progressive rate structure that taxes ordinary income at one of seven rates: 10%, 15%, 25%, 28%, 33%, 35%, or 39.6% There are four tax filing categories, including single, married filing together, married filing separately, and head of house-hold.
Most taxpayers use single and married filing together.
The table shows the tax rates and income brackets for the two major filing categories.
You pay more taxes as your income increases, but you also pay more taxes as your income rises into a higher band.
Cash dividends, interest, profits from a sole propri etorship or share in a partnership, and gains from the sale of securities or other assets are included.
There is a distinction between ordinary income and capital gains.
The form in which the income is received is irrelevant.
If you owe a debt to someone and they forgive it, you may have to report the amount as income for tax purposes, depending on how the debt was initially created and treated for tax purposes in previous periods.
Unless it is considered a long-term capital gain or dividend, most income is taxed as ordinary income.
The tax law treats gains and losses from the sale of capital assets differently from ordinary income.
Capital assets include a house, car, shares of stock, bonds, and stamp collections.
Capital losses for personal property can't be claimed as a loss for tax purposes.
Depending on how long the capital asset was held, the capital gain may be taxed at a lower rate than income.
There is a maximum of $3,000 of losses in excess of capital gains that can be claimed.
The losses that can't be applied in the current year can be carried forward to future years.
A series of steps are needed to determine taxable income.
The income tax situation of the Meyer family, Edward, Martha, and their 17-year-old child, is illustrated more clearly by an example.
The family had a number of deductions.
The income tax bill for the year was $4,785 for the state and local income taxes, as determined in Table 17.2 on page 17-5 and explained below.
The tax law allows certain exclusions for certain income levels, but gross income begins with all income.
All income is included except interest on the tax-free municipal bonds, which are not subject to federal income tax, and the dividends, since they are in the 15% tax brackets.
Short-term capital gains and interest on savings accounts are included.
The intent of Congress to favor certain activities is reflected in the adjustments to gross income.
The allow able IRA contribution of $3,000 was the only one shown for the Meyers.
Without the tax-sheltering quality of the IRA, the Meyers would have paid taxes on an additional $3,000 of income.
Subtracting the adjustment from gross income yields adjusted gross income.
For single taxpayers, the standard deduction was $6,200, for married couples it was $12,400.
The standard deduction is higher for taxpayers who are older and blind.
If they choose to take it, the standard deduction is $12,400.
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