Definitions Relative to Preferred Stock and Baby Bonds

Baby Bonds

The same as exchange traded debt.  A baby bond is simply a bond with a face value of under $1,000. Typically this is $25, $50 or $100.  They may be called Notes, Senior Notes, Debentures, Junior Debentures or a number of others. Generally these rank ahead of common and preferred stock in the capital stack, but below secured debt as baby bonds are almost always unsecured, although there are some utility baby bonds that are secured by utility assets.

Bonus Coupon Rate

Some preferred stocks contain a provision in their offering prospectus which requires that if the issuer does NOT redeem an issue by a certain day the coupon will step up to a higher rate until the shares are redeemed.  This is not a common provision, but it occurs from time to time and is used as provision to make a new issue more attractive to investors.

Callable

see Redeemable below.  Sometimes used to describe redeemable issues.

Change of Control

If a company is bought or someone purchases a controlling interest many preferred shares have provisions for holders to redeem their shares. Because of this provision even though an issue is not technically yet redeemable by date it is possible that the issue would get redeemed early in a merger etc.

Coupon

The stated percentage that the company will pay on either debt or preferred stock.  The dividend is calculated by multiplying the coupon percentage times the face value of the issue (i.e. 8% X $25 = $2.00/annually or 50 cents quarterly).

Cumulative Preferred Stock

If dividends are not declared they will continue to accrue and must be paid prior to other dividends being paid. Sometimes a company may find it necessary to suspend dividends for many years.

Current Yield

The current yield of a particular preferred stock is the yield (percentage) the shares are currently yielding based upon the share price.

Debentures

See baby bonds above

Dividends

Dividends are the payments you receive by investing in common or preferred stock.  Dividends are many times eligible for preferential tax treatment by the U.S. federal government and are taxed at the lower capital gains tax rate.  Dividends of REITs, MLPs and BDCs are not eligible for preferential tax rates.

Duration

While many investors refer to “duration” as the length of time to maturity that is only “kind of right”. Duration is really a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices.

Ex-Dividend Date

This is the date that the security begins to trade without the dividend (ex-dividend). Normally the price of the security will trade at a price on this date that is the amount of the dividend below the previous days closing price.

Fixed-to-Floating Rate

Both preferred stock and baby bonds are sometimes issued with an initial fixed rate before converting to a floating rate, normally 5 or 10 years after issuance.

Floating Rate

Both preferred stock and baby bonds are sometimes issued with “floating rate” coupons.  These typically adjust every 3 months based upon a a base rate plus a floating rate (such as 3 month libor). These typically have a minimum coupon rate.

Free Writing Prospectus

A document filed with the Securities and Exchange Commission (SEC) that is used when a company “prices” a new stock or bond issue. Also called a FWP.  Also as the new indicates companies can use it for any number of miscellaneous items they need to file with the SEC

Interest

Interest is what you are paid for “lending” a company money by purchasing their bonds.  Interest received is NOT eligible for preferential tax treatment in the U.S. and is taxed at ordinary tax rates.

Investment Grade

Preferred stocks that are rated at or above BBB- by Standard and Poors and at or above Baa3 by Moodys are classified as investment grade.

Junk Rated

Most preferred stocks are not rated or carry ratings that are below investment grade ratings.  We refer to these as “junk”.  While the security may well not be “junk” any security below investment grade is called junk.

Junior Debentures

See baby bonds above.

Maturity Date

The stated date when the issuer will return your capital to holders of bonds.

Monthly Payor

There are some preferred stocks that pay their dividends on a monthly basis instead of quarterly.

Non-Cumulative Preferred Stock

If a dividend is not declared by a board of directors there is no obligation to pay the missed dividend in the future. Banks and insurance companies generally issue non-cumulative preferred stock OR it will not be allowed to be used as Tier 1 capital.

Pari Passu

Pari Passu is a term used in prospectuses to describe securities that are “equal” to each of in terms of ranking in the event of a liquidation.  Most preferred stocks are “pari passu” within the capital stack–meaning if a company has 5 issues outstanding they rank equal with each other no matter when they were issued.

Participating Preferred

There a few (very few) preferred stock issues that are “participating”.  This means that the preferred stock holders may “participate” in profits above and beyond the normal stated coupon rate.

Penalty Rate

There are a few preferred issues that have a penalty (or bonus) coupon rate paid if shares are not redeemed by a certain date.  While these shares are technically perpetual in regards to maturity they are viewed more like a term preferred.

Perpetual

This means having NO maturity date.  Most preferred stocks are issued with a maturity date thus the issuer is under no obligation to ever redeem the shares.

Prospectus

The document filed with the Securities and Exchange Commission (SEC) which lays out the specific terms of a stock or bond issue.

Qualified Distribution (or dividend)

The term refers to distributions and dividends that are qualified to receive preferential tax treatment on your income taxes. This means that your rate is the lower capital gains rate, instead of the ordinary tax rate. Banks and insurance companies are typical preferred stock issuers that pay qualified distributions. REITs, mlps and BDCs pay non-qualifie ddistributions.

Redeemable

The issuer has the option to redeem (or call) the shares at a fixed price after a period of time.  For instance most preferred stock is “redeemable” 5 years after issuance at the option of the issuer at $25 plus accrued dividends. Note that the redemption is optionable at the option of the issuer and whether the shares are redeemed or not depends on the current level of interest rates.  If rates are moving higher there is less chance issues will be redeemed while if interest rates are moving lower companies will redeem issues so they can reissue at a lower coupon and thus save money.

Redemption Date

The date that a preferred stock becomes optionally redeemable. Generally this is about 5 years after issue, although it can be any amount of time as spelled out in the original prospectus.

Senior Notes

see baby bonds

Term Preferred Stock

There are a limited number of preferred stock issues that have mandatory redemption dates-we call these “term preferreds”.  In most other respects they are like all other preferreds, but instead of being “perpetual” they have a “date certain” for redemption.

Voting Rights

Baby bonds and preferred stock holders are seldom given voting rights, which are reserved for common stock shareholders.  It should be noted that when a company misses a preferred stock dividend there are at times provisions for preferred holders to elect a certain number of board members. In reality this is seldom a factor in any preferred stock issue.