“In most cases, preferred stock does not appreciate in price unless interest rates fall.” - and vice versa.
Need some help understanding why this is the case.
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Hey @Matthew, good question.
Here’s an example that might help illustrate why it works this way.
An investor buys a newly issued 5%, $100 par preferred stock at par when interest rates are averaging 5%. A few years later, interest rates fall to 3%.
The 5% preferred stock is very valuable. The investor owns an investment that pays $5 annually per share, while other investors purchasing new $100 par preferred stock today are receiving $3 per share annually.
The investor could easily ask for more money than their original investment of $100. With a market interest rate of 3%, investors know the 5% preferred stock is valuable. If they offered to sell their shares for the original $100 purchase price, it would be sold immediately.Due to the demand for the preferred shares, the investor can raise the price. By doing so, they’re able to obtain a capital gain and increase their overall return on the investment.
Here’s the chapter where we focus on this:
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One more thing too @Matthew - preferred stocks compete for the same investors that seek out bonds. While preferred stocks don’t pay interest, their values are consistently compared to bond values. If bond interest rates fall to 3%, then a 5% preferred stock will be more valuable. More value = higher demand, driving prices upward.
Hope this helps!
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