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Preferred Securities

One-line definition

A hybrid security senior to common stock but subordinate to bonds in the capital structure — usually paying a fixed dividend, with no maturity date (perpetual), which makes it price like a perpetuity bond far more than like common equity.

Formula

value = dividend / required_return — a perpetuity with zero growth.

This repo already has the exact function needed: pm.equity.valuation.gordon_growth_value(dividend_next, required_return, growth_rate=0.0) reduces to precisely this formula when growth_rate=0, since Gordon growth's D1 / (r - g) becomes D1 / r at g=0. No new function is needed for a non-callable, non-convertible, fixed-rate preferred — it's the same math already built for equity valuation.

Why PMs care

Preferred dividends sit ahead of common dividends in payment priority (and ahead of common shareholders in a liquidation, though behind all bondholders) but behind bond coupons in seniority — which is why preferreds trade with a risk/return profile between the two. Because most preferreds are perpetual with a fixed dividend, their price behaves like a very long-duration bond: highly sensitive to changes in the required return (largely driven by rates and the issuer's credit spread), the same interest-rate sensitivity logic as duration applied to an infinite-maturity instrument instead of a fixed one.

Worked example

A preferred paying a $2.00 annual dividend, required return 8%:

value = 2.00 / 0.08 = $25.00 (gordon_growth_value(dividend_next=2.0, required_return=0.08, growth_rate=0.0) reproduces this exactly.)

If the required return rises to 10% (rates or credit spreads widen), the same preferred is worth 2.00 / 0.10 = $20.00 — a 20% price decline from a 2-point move in required return, illustrating just how rate-sensitive a perpetual, fixed-dividend instrument is.

Vocabulary

  • Cumulative vs. non-cumulative: a cumulative preferred's skipped dividends accrue and must be paid before any common dividend resumes; a non-cumulative preferred's skipped dividends are simply gone.
  • Callable: most preferreds are callable by the issuer after some date, which caps upside the same way a callable bond's price is capped near the call price — see OAS for the general embedded-option framing.
  • Convertible preferred: convertible into common stock, combining this page's perpetuity logic with convertible bonds's conversion-value logic.

Common mistakes

  • valuing a callable preferred with the plain perpetuity formula and no adjustment — a preferred trading above its call price on this formula alone is ignoring the real possibility of being called away at that price
  • treating preferred dividends as legally guaranteed the way bond coupons are — for most preferreds (especially non-cumulative), the issuer can skip the dividend without triggering a default, a materially different risk than missing a bond coupon
  • forgetting the perpetuity formula only fits a plain, fixed-rate, non-convertible, non-callable preferred — real preferred structures usually have at least one of these complicating features

Why call/convertible features aren't implemented in src/pm

A callable preferred needs the same embedded-option machinery this repo's OAS page explains is out of scope; a convertible preferred needs convertible bonds's conversion math layered on top of the perpetuity value. The plain-vanilla case above is fully codeable today by reusing gordon_growth_value — the complicating features are each a real, separately-scoped project.

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