Convertible Adjustable Preferred Stock - Explained
What is Convertible Adjustable Preferred Stock?
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Table of ContentsWhat is Convertible Adjustable Preferred Stock?How does Convertible Adjustable Preferred Stock (CAPS) Work? What is Convertibility?What is Adjustability?Taxation of CAPSAcademic Research on Convertible Adjustable Preferred Stock (CAPS)
What is Convertible Adjustable Preferred Stock?
Convertible Adjustable Preferred Stock are preferred shares of stock that holders can exchange for a given number of the company's common stock shares. This exchange can occur at any time chosen by the investor, irrespective of the market price of the common stock.
The interest rate on Convertible Adjustable Preferred Stock (CAPS) is adjustable and is ascribed to the Treasury security rates. They can both be exchanged at par value for common stock or cash after the company announces the date of its next dividend. The CAPS is a type of security formed from different entities with characteristics of both debt and equity. It can be exchanged at a future date, either for common stock shares or issuance of new equity.
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How does Convertible Adjustable Preferred Stock (CAPS) Work?
Convertible Adjustable Preferred Stock also known as Capital Market Preferred Stock (CMPS), protects an investor's principal while still allowing him to take advantage of upward trends in the company's value. It makes available a floating rate which is specifically indexed to a Treasury security. These shareholders can either decide to convert their CAPS to common stocks on the day dividends are paid or not. There is an equality between the number of common shares received and the par value of the preferred stock. This equality allows investors to preserve the capital feature in case of if the issuer's credit rating were to decline. A cap is usually placed on the number of shares received upon conversion.
What is Convertibility?
Convertibility can be defined as the quality which enables money or other financial instruments to be converted into other liquid stores of value, that is, retention of purchasing power into the future. Convertibility is an important factor in Convertible Adjustable Preferred Stock where the rules and regulations are established when the preferred stock is first given out. The bonds can be converted into common stock at a given rate at the holder's discretion or continue to collect dividends. Suppose an issued preferred stock has a 5% dividend and a $1,000 par value and is convertible into 100 shares of common stock after two years. This is a 10:1 conversion ratio. This means a break-even common stock price of $10 per share.
What is Adjustability?
Individual stocks of an index will intermittently pay dividends to shareholders. When this happens, there is an effect on the overall value of the index causing it to fall by a certain amount. Its worthy to note that index traders who have influence can neither profit nor lose from these price movements since theyre planned public events. The adjustment term which would have been stated in the dividend's offering documents at the time it was issued helps to reduce fluctuations in the market price of CAPS shares, thereby, protecting investors from possible capital loss which are usually related to the standard fixed-income securities when interest rates are rising.
Taxation of CAPS
Preferred stock dividends are generally taxed differently as compared to other assets. They are taxed lower than regular income when they are qualified. A U.S. company is said to be qualified if it exhibits a normal corporate structure and trade on any one of the major U.S. exchanges. The investor must have owned it for a period greater than 60 days of the holding period. Recent changes made to the tax law give income investors more savings as compared to before. For example, dividend and capital gains are taxed at 20% for investors earning > $425,800 and households earning > $479,901. Whereas, individuals earning between $38,601 - $425,800 are taxed at 15% for long-term capital gains.
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