Adjustable Rate Preferred Stock - Explained
What is Adjustable Rate Preferred Stock?
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Table of ContentsWhat is Adjustable-Rate Preferred Stock?How is Adjustable-Rate Preferred Stock Used? Boundaries in PlaceAcademic Research on Adjustable-Rate Preferred Stock ARPS
What is Adjustable-Rate Preferred Stock?
Adjustable-Rate Preferred Stock is a form of preferred stock where the dividend paid will have variations with a benchmark rate, generally that of a T-bill. The valuation of dividend from preferred shares is ascertained beforehand with a formula so as to be flexible with rates, and due to this flexibility, prices are usually more consistent in nature than fixed-rate preferred stocks.
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How is Adjustable-Rate Preferred Stock Used?
When the company liquidates, preferred shareholders are given preference of receiving dividends, thereby making the preferred stocks safer and more reliable. Also, the restriction on the change of rate of dividend adds more cushion to the issue. Besides, the dividends of ARPS can be adjusted to match the existing rates of interest, or other rates of interest prevailing in the money market. This generally takes place every quarter.
Consistent dividend payouts coupled with the consistency in market value offered by adjustable-rate preferred stock add another advantage for investors seeking fixed and stable returns, and the protection of their capital. Adjustable preferred-stocks have similar advantages and disadvantages to offer similar to fixed-rate preferred stocks. During the liquidation process, the companies tend to pay dividends to preferred stockholders before making dividend payments to common stockholders. However, there are a few differences between adjustable preferred stock and non-adjustable stock.
The rates of adjustable preferred stock dividends are associated with a standard index or reference rate. With the decrease of reference interest rate, the dividend rate of adjusted preferred stock falls as well. As a result, the investors end up receiving lesser dividends, and there are less or almost no changes in stock price with these securities in contrast to fixed-rate preferred stocks where stock prices have an inverse relationship with interest rates.
Boundaries in Place
Adjustable preferred stocks consist of fixed standards called collars. These primarily consist of caps and floors positioned on dividend yields. A floor represents the minimal amount of dividend that adjustable preferred stockholders would receive, no matter if rates of interest fall below the floor rates. As opposed to floor, a cap sets the maximum yield that stockholders will receive as dividend, and this naturally can be an unpleasant factor for investors.
APS work just like fixed-rate preferred stocks when interest rates drop on the other side of collar limit. Many adjustable preferred stocks consider timely auctions for revising dividend yield. The participants of yield consist of both existing and prospective shareholders, and the APS dividend yields are based on investors current objectives.
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