Liquidation Preference

  

Categories: Investing

See: Preferred Stock. See: Liquidity Preference.

You get liquid ahead of everyone else. That is, you have a preference with your preferred shares, such that you get to sell them...or rather, get paid back your investment before the common shareholders get a dime.

Liquidity preference: a good thing if you have it.

Related or Semi-related Video

Finance: What is Adjustable Rate Preferr...15 Views

00:00

Find it a la shma What is adjustable rate preferred

00:06

stock Okay let's start with the basics preferred stock and

00:11

yes we have a whole video on this one as

00:12

well Preferred stock generally pays a dividend and is often

00:17

convertible into common stock at a premium to where it

00:21

was issued So preferred stock is kind of bond like

00:26

and kind of equity Like fish Most preferred stocks get

00:30

issued some set dividend like a base rate of say

00:33

six percent or something like that And note that it's

00:36

called a dividend in the case of preferred stock not

00:41

an interest payment subtle but very important difference here because

00:45

interest on bonds is tax as ordinary income and dividends

00:49

on equities are qualified meaning that their tax at long

00:54

term gains rates or dividend tax rates anyway these preferred

00:58

pay six percent no matter what the price at which

01:02

one preferred unit trades will fluctuate like a stock or

01:06

bond But that thousand dollars par preferred will just continue

01:11

to pay its sixty bucks a year in dividends until

01:14

the preferred shares are bought back by the company you

01:17

know at some premium or until the shares convert into

01:20

being common stock or the company goes bankrupt in armageddon

01:24

scenario one starring ben affleck jr But in the case

01:28

of adjustable rate preferreds it's not always the six percent

01:32

that gets paid or whatever the initially stated rate wass

01:36

in the case of these equities and yes preferred stocks

01:39

considered equity even though it acts like a bond Sometimes

01:42

in this case the dividends will very with some set

01:45

indexed like t bills or live or where the preferred

01:50

dividend might be set on a say a trailing four

01:53

quarter bases to be two hundred basis points Mohr interest

01:58

that it pays than the average t bill reign as

02:02

of blah blah blah blah time frame Well why would

02:05

you want this adjustable feature with preferreds Well you can

02:09

imagine a scenario in a low interest rate environment where

02:13

we have preferred stocks paying five percent and the prevailing

02:16

rates are three percent for very high quality dead teo

02:20

top notch blue chip companies But then we get inflation

02:25

and that three percent for the best borrowers goes to

02:28

six percent and a given preferred stock would then need

02:32

to pay more like eight percent to be trading around

02:35

The thousand dollars par value it was issued at So

02:38

said another way if that piece of paper is on

02:41

ly giving investors fifty bucks a year when a very

02:45

similar piece of paper gives investors eighty bucks a year

02:49

investors will want charity They will sell down than thousand

02:54

dollar piece of paper giving only fifty bucks to price

02:57

low And so that when it's bought it pays eighty

03:02

bucks a year in charity right that thousand dollars going

03:05

to sell down to nine hundred eight hundred seven hundred

03:08

until whatever you pay for it pay the same interest

03:10

rate is that eighty dollars year thing Thank you Inflation

03:13

specifically In this case a thousand dollars preferred paying fifty

03:17

bucks a year would have to sell for six hundred

03:21

twenty five bucks teo yield eight percent meaning that the

03:26

thousand dollars par value that investors bought in a five

03:29

to ten years ago would drop dramatically by three hundred

03:32

seventy five dollars a unit to be six hundred twenty

03:36

five dollars To be quote at market unquote and that's

03:40

a problem a big risk that investors will hate Hence

03:44

the invention of the adjustable feature here Adjustable rate preferred

03:49

Stock Great inventions So in this case if it preferred

03:53

was adjustable if rates went up a cz were describing

03:56

here then it is extremely likely that the t bill

04:00

or live or rates would go up similarly as they

04:03

generally follow inflation grids over time And in this scenario

04:08

if the rate of the dividend on the preferred stock

04:11

at just's then it's always going to be something like

04:15

t bill ray plus three hundred basis points or something

04:18

like that so that if there really is big inflation

04:22

and federal funds rates go from three percent to six

04:25

percent The return on these preferreds would go up about

04:29

the same amount making the security much more appealing to

04:33

investors Got all that well let's Just hope that if

04:36

anything else is in need of getting adjusted those investors

04:39

will take care of it in private nia do that

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