Covered Bonds
February 12, 2025
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Whenever the topic of fixed income securities is considered, the obvious assumption many investors make is that the conversation is about bonds. It is true that bonds are the most commonly traded types of fixed-income securities. However, they are not the only type of fixed-income securities.
Preferred shares are another common type of fixed income security that is used widely by investors all over the world.
In this article, we will have a closer look at how preferred shares work.
Preferred shares are considered to be hybrid securities. This means that they have the characteristics of both debts as well as equity investments. On the balance sheet of a company, they are officially classified as equity. There are some characteristic issues of preferred shares which have been mentioned in the article below:
Also, just like bonds, these securities also provide periodic payments, which could be disbursed quarterly, semi-annually, or annually. It is important to note that these periodic payments are called preferred dividends and not coupon payments.
However, like debt, there is no obligation to make payments in the absence of a profit. Also, if a company fails to make a periodic payment, it would not trigger a default like debt securities.
Preferred shares are issued by a lot of companies across the world. This is because these shares provide certain distinct benefits.
Firstly, preferred shares are used by promoters to pay themselves compensation.
As a result, they help organizations meet regulatory norms. This is why they are issued by companies even though they have to pay a slightly higher interest rate as compared to bonds. These shares help companies raise capital while not reducing their borrowing capacity or skewing their debt-to-equity ratio.
Lastly, it is important to realize that not all classes of preferred shares are the same.
It is common for companies to issue two or three different classes of preferred shares wherein each of these shares has different features and receives different compensation in return. The higher class of preferred shares may have more debt-like features which make them rank higher in seniority whereas the lower classes may have more equity-like features.
The bottom line is that preferred shares are a very important segment within the fixed-income securities market. It is important for investors to be cognizant of the various kinds of opportunities that they can take advantage of if they want to trade in preferred shares.
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