What Is Convertible Redeemable Preferred Stock?

Convertible redeemable preferred stock is an interest-bearing investment with many complex features. Unlike a common stock, which simply represents ownership in a company and does not carry any conversion or redemption features, a convertible redeemable preferred stock can be transformed in many ways. You should have a thorough understanding of all of the features of such a stock before you contemplate purchase.

Preferred stock combines many features of common stocks with those of bonds. Like a bond, a preferred stock pays a stated dividend rate, generally twice a year. Like a stock, preferreds represent ownership in a company. Some preferred stocks trade on a stock exchange, but others trade like bonds in the over-the-counter market, on bond trading desks. As a preferred stock pays a fixed dividend, the value of the preferred generally fluctuates in line with current interest rates.

A convertible preferred can be exchanged into shares of common stock at the discretion of the shareholder. Usually, a preferred cannot be converted until a certain date after issuance, often five years or longer, and only at a specified price.

A call feature is a provision that allows an issuer to redeem a security at a specified price on a specified date or later. For example, a company may issue a preferred stock with a five-year call provision at $25, allowing the company to purchase your preferred from you for $25 per share at any time more than five years in the future. A call feature is a way for a company to protect itself from paying a high rate of interest for too long. If a preferred stock pays a 10 percent dividend, and interest rates fall to the point where the company can issue new preferred stock paying just 3 percent, then it would be in the company's best interest to redeem the 10 percent preferred stock and issue the new 3 percent stock.

In the event of the liquidation of a company, assets are distributed according to the priority of the capital structure. At the top of the list are bondholders, followed by preferred shareholders and finally common stockholders. Thus, preferred stock is considered to be junior to bonds, but senior to common stock.

Convertible redeemable preferred stocks are susceptible to changes in interest rates, and increases in rates tend to diminish their value. The guarantee of the preferred dividend is only as secure as the financial stability of the underlying company. The call feature of the preferred poses another risk, as the company may call away a high-paying preferred stock at a time when you can only reinvest your proceeds in lower-paying securities.