Covered Bonds
February 12, 2025
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In the previous article, we understood what preferred shares are and also paid attention to their characteristic features. In this article, we will take the conversation forward by understanding the pros and cons of investing in preferred shares. An analysis of the commonly stated pros and cons helps investors evaluate the use of preferred shares for their specific investment objectives.
The details of the advantages and disadvantages have been explained in this article.
There are several advantages of investing in preferred shares from an investor’s point of view. The details of these advantages have been mentioned below:
Investors are generally keen on investing in preferred shares which have convertible features. This is because they get the best of both worlds i.e. a fixed income at a higher rate in the initial years and an option to convert the preferred shares to common stock only if it is beneficial for them to do so.
While investment in preferred shares is generally considered to be a safe bet, there are several disadvantages that result from such investments as well. Details of some of these disadvantages have been mentioned below:
Here, there are other types of risks that need to be accounted for. For instance, the issuer may not be able to make dividend payments in a given year and may have to defer the same. In such cases, preference shareholders have no recourse and have to forego the payment that year. This means that the investors cannot rely completely on these dividend payments as a source of their income.
They are only senior to equity shareholders when it comes to the dissolution of the firm. Hence, it can be said that they do face the risk of default to some extent. This makes preference shares riskier since the downside is the same as bonds but the upside is less as compared to bonds.
The market value of the preference share is not taken into account while deciding on the compensation to be provided to the shareholder. Similarly, the preference shares may be redeemable. In such cases, the investor and not the issuer may have an option to unilaterally force the company to buy back their shares at the original price. Once again, the prevailing market price is not taken into consideration.
Preference shares may be retracted if their market value is far above their par value and may be redeemed in the opposite case. In either case, one party may have the power to enforce a disadvantageous trade on their counterpart. This is one of the reasons which makes investing in preference shares dangerous.
The reality is that preferred shares have an intermediate level of risk and provide a commensurate return. However, since preferred shares are generally issued by companies in the banking and financial sector and these companies are less prone to default as compared to other companies, these shares are generally considered to be a safe bet.
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