What is the function of cumulative convertible preferred stock?

What is the function of cumulative convertible preferred stock?

• A. Only provides fixed dividends
• B. Can be converted into common stock and must pay dividends in arrears before common stock dividends
• C. Is issued exclusively to large institutional investors
• D. Is not influenced by stock prices

Answer: (B)

Cumulative convertible preferred stock serves a unique purpose in the financing structure of a company. The correct choice highlights two critical functions: it can be converted into common stock and it must pay any overdue dividends before any dividends can be paid to common stockholders. The ability to convert into common stock gives investors an opportunity to participate in the company's upside potential if the company's common shares increase in value. Meanwhile, the cumulative feature ensures that if the company ever misses a dividend payment, those unpaid dividends accrue and must be settled before any dividends are distributed to common stockholders. This dual feature makes cumulative convertible preferred stock an attractive investment option, balancing potential equity growth with assurances around dividend payments. In contrast, the other answers do not accurately encompass both key functions of cumulative convertible preferred stock. The focus on fixed dividends, exclusivity to institutional investors, or the claim that it is not influenced by stock prices does not capture the comprehensive attributes that make this type of preferred stock distinct and valuable to investors.

Cumulative convertible preferred stock serves a unique purpose in the financing structure of a company. The correct choice highlights two critical functions: it can be converted into common stock and it must pay any overdue dividends before any dividends can be paid to common stockholders.

The ability to convert into common stock gives investors an opportunity to participate in the company's upside potential if the company's common shares increase in value. Meanwhile, the cumulative feature ensures that if the company ever misses a dividend payment, those unpaid dividends accrue and must be settled before any dividends are distributed to common stockholders. This dual feature makes cumulative convertible preferred stock an attractive investment option, balancing potential equity growth with assurances around dividend payments.

In contrast, the other answers do not accurately encompass both key functions of cumulative convertible preferred stock. The focus on fixed dividends, exclusivity to institutional investors, or the claim that it is not influenced by stock prices does not capture the comprehensive attributes that make this type of preferred stock distinct and valuable to investors.