Question

What type of risk is evident with preferred shares?

Answer 1

Preferred shares carry credit, interest rate, and market risks, with the potential for reduced dividends, decline in value with rising interest rates, and price volatility due to market fluctuations.

Step-by-step explanation:

The type of risk associated with preferred shares is related to their fixed income nature which is similar to bonds. These shares offer a fixed dividend, but they are subject to certain risks, including credit risk, interest rate risk, and market risk. Credit risk occurs when the issuing company faces financial difficulties and may not be able to pay dividends or return the principal at maturity. Interest rate risk is the possibility that the value of the preferred shares will decline due to rising interest rates, as preferred shares may become less attractive compared to newer issues paying higher dividends. Lastly, market risk involves the uncertainty due to market fluctuations that can affect the share price independent of the issuing company's performance.

Answer 2

Preferred shares carry risks such as credit risk, interest rate risk, and liquidity risk, resembling both equity and debt instruments, with their value being sensitive to the issuing company's financial health and changes in interest rates.

Step-by-step explanation:

The type of risk that is evident with preferred shares entails a mix of debt and equity features. Preferred shareholders receive dividends before common shareholders and can have their payments adjusted for inflation or interest rate changes. However, they face credit risk if the issuing company fails to make scheduled dividend payments. In such a case, similar to bondholders, preferred shareholders have a claim on the company's assets, but this is generally after bondholders are paid. Moreover, preferred shares carry interest rate risk. When interest rates rise, the value of preferred shares, much like bonds, tends to fall since newer issues may offer higher yields, making the older, lower-yielding issues less attractive. Another potential risk involves liquidity, as preferred shares may be less liquid than common stocks, making them more difficult to sell at a fair price quickly.