Financial Terms Cost of Preferred Stock

# Definition of Cost of Preferred Stock

## Cost of Preferred Stock

The rate of return required by the investors in the preferred stock of
a company. A component of the cost of capital.

# Related Terms:

## Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

## Acquisition of stock

A merger or consolidation in which an acquirer purchases the acquiree's stock.

## Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

## Agency cost view

The argument that specifies that the various agency costs create a complex environment in
which total agency costs are at a minimum with some, but less than 100%, debt financing.

## Agency costs

The incremental costs of having an agent make decisions for a principal.

## All-in cost

Total costs, explicit and implicit.

## American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.

## Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

## Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.

## Bankruptcy cost view

The argument that expected indirect and direct bankruptcy costs offset the other
benefits from leverage so that the optimal amount of leverage is less than 100% debt finaning.

## Beta equation (Stocks)

The beta of a stock is determined as follows:
[(n) (sum of (xy)) ]-[(sum of x) (sum of y)]
[(n) (sum of (xx)) ]-[(sum of x) (sum of x)]
where: n = # of observations (24-60 months)
x = rate of return for the S&P 500 Index
y = rate of return for the stock

## Carring costs

costs that increase with increases in the level of investment in current assets.

## Common stock

These are securities that represent equity ownership in a company. Common shares let an
investor vote on such matters as the election of directors. They also give the holder a share in a company's
profits via dividend payments or the capital appreciation of the security.

## Common stock/other equity

Value of outstanding common shares at par, plus accumulated retained
earnings. Also called shareholders' equity.

## Common stock equivalent

A convertible security that is traded like an equity issue because the optioned

## Common stock market

The market for trading equities, not including preferred stock.

## Common stock ratios

Ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.

## Conflict between bondholders and stockholders

These two groups may have interests in a corporation that
conflict. Sources of conflict include dividends, distortion of investment, and underinvestment. Protective
covenants work to resolve these conflicts.

## Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.

## Convertible preferred stock

preferred stock that can be converted into common stock at the option of the holder.

## Cost company arrangement

Arrangement whereby the shareholders of a project receive output free of
charge but agree to pay all operating and financing charges of the project.

## Cost of capital

The required return for a capital budgeting project.

## Cost of carry

Related: Net financing cost

## Cost of funds

Interest rate associated with borrowing money.

## Cost of lease financing

A lease's internal rate of return.

## Cost of limited partner capital

The discount rate that equates the after-tax inflows with outflows for capital
raised from limited partners.

## Cost-benefit ratio

The net present value of an investment divided by the investment's initial cost. Also called
the profitability index.

## Cumulative preferred stock

preferred stock whose dividends accrue, should the issuer not make timely
dividend payments. Related: non-cumulative preferred stock.

## Direct stock-purchase programs

The purchase by investors of securities directly from the issuer.

## Dividend yield (Stocks)

Indicated yield represents annual dividends divided by current stock price.

## Employee stock fund

A firm-sponsored program that enables employees to purchase shares of the firm's
common stock on a preferential basis.

## Employee stock ownership plan (ESOP)

A company contributes to a trust fund that buys stock on behalf of
employees.

## Equivalent annual cost

The equivalent cost per year of owning an asset over its entire life.

## Exchange of stock

Acquisition of another company by purchase of its stock in exchange for cash or shares.

## Execution costs

The difference between the execution price of a security and the price that would have
existed in the absence of a trade, which can be further divided into market impact costs and market timing
costs.

## Financial distress costs

Legal and administrative costs of liquidation or reorganization. Also includes
implied costs associated with impaired ability to do business (indirect costs).

## Fixed cost

A cost that is fixed in total for a given period of time and for given production levels.

## Floating-rate preferred

preferred stock paying dividends that vary with short-term interest rates.

## Friction costs

costs, both implied and direct, associated with a transaction. Such costs include time, effort,
money, and associated tax effects of gathering information and making a transaction.

## Growth stock

Common stock of a company that has an opportunity to invest money and earn more than the
opportunity cost of capital.

## Income stock

Common stock with a high dividend yield and few profitable investment opportunities.

## Incremental costs and benefits

costs and benefits that would occur if a particular course of action were
taken compared to those that would occur if that course of action were not taken.

## Information costs

Transaction costs that include the assessment of the investment merits of a financial asset.
Related: search costs.

## Letter stock

Privately placed common stock, so-called because the SEC requires a letter from the purchaser
stating that the stock is not intended for resale.

## Listed stocks

stocks that are traded on an exchange.

## Listed stocks

stocks that are traded on an exchange.

## Margin account (Stocks)

A leverageable account in which stocks can be purchased for a combination of
cash and a loan. The loan in the margin account is collateralized by the stock and, if the value of the stock
drops sufficiently, the owner will be asked to either put in more cash, or sell a portion of the stock. Margin
rules are federally regulated, but margin requirements and interest may vary among broker/dealers.

## Market impact costs

Also called price impact costs, the result of a bid/ask spread and a dealer's price concession.

## Market segmentation theory or preferred habitat theory

A biased expectations theory that asserts that the
shape of the yield curve is determined by the supply of and demand for securities within each maturity sector.

## Market timing costs

costs that arise from price movement of the stock during the time of the transaction
which is attributed to other activity in the stock.

## Monthly income preferred security (MIP)

preferred stock issued by a subsidiary located in a tax haven.
The subsidiary relends the money to the parent.

## Net financing cost

Also called the cost of carry or, simply, carry, the difference between the cost of financing
the purchase of an asset and the asset's cash yield. Positive carry means that the yield earned is greater than
the financing cost; negative carry means that the financing cost exceeds the yield earned.

## New York Stock Exchange (NYSE)

Also known as the Big Board or The Exhange. More than 2,00 common
and preferred stocks are traded. The exchange is the older in the United States, founded in 1792, and the
largest. It is lcoated on Wall Street in New York City

## Non-cumulative preferred stock

preferred stock whose holders must forgo dividend payments when the
company misses a dividend payment.
Related: Cumulative preferred stock

## Opportunity cost of capital

Expected return that is foregone by investing in a project rather than in
comparable financial securities.

## Opportunity costs

The difference in the performance of an actual investment and a desired investment
adjusted for fixed costs and execution costs. The performance differential is a consequence of not being able
to implement all desired trades. Most valuable alternative that is given up.

A securities exchange where American and European foreign
currency options on spot exchange rates are traded.

## Preferred equity redemption stock (PERC)

preferred stock that converts automatically into equity at a
stated date. A limit is placed on the value of the shares the investor receives.

## Preference stock

A security that ranks junior to preferred stock but senior to common stock in the right to
receive payments from the firm; essentially junior preferred stock.

## Preferred habitat theory

A biased expectations theory that believes the term structure reflects the
expectation of the future path of interest rates as well as risk premium. However, the theory rejects the
assertion that the risk premium must rise uniformly with maturity. Instead, to the extent that the demand for
and supply of funds does not match for a given maturity range, some participants will shift to maturities
showing the opposite imbalances. As long as such investors are compensated by an appropriate risk premium
whose magnitude will reflect the extent of aversion to either price or reinvestment risk.

## Preferred shares

preferred shares give investors a fixed dividend from the company's earnings. And more
importantly: preferred shareholders get paid before common shareholders. See: preferred stock.

## Preferred stock

A security that shows ownership in a corporation and gives the holder a claim, prior to the
claim of common stockholders, on earnings and also generally on assets in the event of liquidation. Most
preferred stock pays a fixed dividend that is paid prior to the common stock dividend, stated in a dollar
amount or as a percentage of par value. This stock does not usually carry voting rights. The stock shares
characteristics of both common stock and debt.

## Preferred stock agreement

A contract for preferred stock.

## Price impact costs

Related: market impact costs

## Replacement cost

cost to replace a firm's assets.

## Repurchase of stock

Device to pay cash to firm's shareholders that provides more preferable tax treatment
for shareholders than dividends. Treasury stock is the name given to previously issued stock that has been
repurchased by the firm. A repurchase is achieved through either a dutch auction, open market, or tender offer.

## Reverse stock split

A proportionate decrease in the number of shares, but not the value of shares of stock
held by shareholders. Shareholders maintain the same percentage of equity as before the split. For example, a
1-for-3 split would result in stockholders owning 1 share for every 3 shares owned before the split. After the
reverse split, the firm's stock price is, in this example, worth three times the pre-reverse split price. A firm
generally institutes a reverse split to boost its stock's market price and attract investors.

## Round-trip transactions costs

costs of completing a transaction, including commissions, market impact
costs, and taxes.

## Search costs

costs associated with locating a counterparty to a trade, including explicit costs (such as
advertising) and implicit costs (such as the value of time). Related:information costs.

## Shortage cost

costs that fall with increases in the level of investment in current assets.

## Stock

Ownership of a corporation which is represented by shares which represent a piece of the corporation's
assets and earnings.

## Stock dividend

Payment of a corporate dividend in the form of stock rather than cash. The stock dividend
may be additional shares in the company, or it may be shares in a subsidiary being spun off to shareholders.
stock dividends are often used to conserve cash needed to operate the business. Unlike a cash dividend, stock
dividends are not taxed until sold.

## Stock exchanges

Formal organizations, approved and regulated by the Securities and Exchange Commission
(SEC), that are made up of members that use the facilities to exchange certain common stocks. The two major
national stock exchanges are the New York stock Exchange (NYSE) and the American stock Exchange (ASE
or AMEX). Five regional stock exchanges include the Midwest, Pacific, Philadelphia, Boston, and Cincinnati.
The Arizona stock exchange is an after hours electronic marketplace where anonymous participants trade
stocks via personal computers.

## Stock repurchase

A firm's repurchase of outstanding shares of its common stock.

## Stock selection

An active portfolio management technique that focuses on advantageous selection of
particular stocks rather than on broad asset allocation choices.

## Stockholder equity

Balance sheet item that includes the book value of ownership in the corporation. It
includes capital stock, paid in surplus, and retained earnings.

## Stock index option

An option in which the underlying is a common stock index.

## Stock market

Also called the equity market, the market for trading equities.

## Stock option

An option in which the underlying is the common stock of a corporation.

## Stock replacement strategy

A strategy for enhancing a portfolio's return, employed when the futures
contract is expensive based on its theoretical price, involving a swap between the futures, treasury bills
portfolio and a stock portfolio.

## Stock split

Occurs when a firm issues new shares of stock but in turn lowers the current market price of its
stock to a level that is proportionate to pre-split prices. For example, if IBM trades at \$100 before a 2-for-1
split, after the split it will trade at \$50 and holders of the stock will have twice as many shares than they had
before the split. See: split.

## Stock ticker

This is a lettered symbol assigned to securities and mutual funds that trade on U.S.financial exchanges.

## Stockholder

Holder of equity shares in a firm.

## Stockholder's books

Set of books kept by firm management for its annual report that follows Financial
Accounting Standards Board rules. The tax books follow IRS tax rules.

## Stockholder's equity

The residual claims that stockholders have against a firm's assets, calculated by
subtracting total liabilities from total assets.

## Stockout

Running out of inventory.

## Sunk costs

costs that have been incurred and cannot be reversed.

costs of buying and selling marketable securities and borrowing. Trading costs include

## Transactions costs

The time, effort, and money necessary, including such things as commission fees and the
cost of physically moving the asset from seller to buyer. Related: Round-trip transaction costs, Information
costs, search costs.

## Treasury stock

Common stock that has been repurchased by the company and held in the company's treasury.

## True interest cost

For a security such as commercial paper that is sold on a discount basis, the coupon rate
required to provide an identical return assuming a coupon-bearing instrument of like maturity that pays
interest in arrears.

## Variable cost

A cost that is directly proportional to the volume of output produced. When production is zero,
the variable cost is equal to zero.

## Weighted average cost of capital

Expected return on a portfolio of all the firm's securities. Used as a hurdle
rate for capital investment.

## BOOK VALUE OF COMMON STOCK

The theoretical amount per share that each stockholder would receive if a companyâ€™s assets were sold on the balance sheetâ€™s date. Book value equals:
(stockholdersâ€™ equity) / (Common stock shares outstanding)

## Cost basis

An assetâ€™s purchase price, plus costs associated with the purchase, like installation fees, taxes, etc.

## Cost of goods sold

The cost of merchandise that a company sold this year. For manufacturing companies, the cost of raw
materials, components, labor and other things that went into producing an item.

## Earnings per share of common stock

How much profit a company made on each share of common stock this year.

## MACRS (Modified Accelerated Cost Recovery System)

A depreciation method created by the IRS under the Tax Reform Act of 1986. Companies must use it to depreciate all plant and equipment assets installed after December 31, 1986 (for tax purposes).

## RATE OF RETURN ON STOCKHOLDERSâ€™ EQUITY

The percentage return or profit that management made on each dollar stockholders invested in a company. Hereâ€™s how you figure it:
(Net income) / (stockholdersâ€™ equity)