Preferred Stock

• There are two primary ways for investors to invest in a company: through stocks or bonds. Stocks represent a form of ownership, and stockholders are compensated for the use of their funds by having the ability to share in price appreciation and/or dividends. Bonds represent a form of debt to the company and a loan for the bond holder. Preferred stock is a hybrid of both stocks and bonds. Preferred stock acts like a bond by paying a rate of interest, but pays the interest out in the form of a dividend.
  
  

Interest Rates

• Interest rates drive the preferred stock market. This is because interest rates represent the cost of money, and if the cost of money goes up, the interest rate on preferred stock will go up. However, if the cost of money goes down, the interest rate on preferred stock will go down. The higher the interest rate, the more return the investor will make on invested funds. However, higher interest rates are also associated with greater risk.
  
  

Prices and Interest Rates

• As the price of money goes up or down over time it influences the preferred stock that has already been issued at a certain interest rate. As the cost of money goes up in the general economy so does the price associated with preferred stocks that were issued at a lower interest rate. This may be a difficult concept for people to understand. For instance, if you owned preferred stock paying an 8 percent rate of interest, and the Federal Reserve raises interest rates to 9 percent, you are missing out on 1 percent of interest as a preferred stockholder. As a result, preferred stock prices tend to go down as interest rates go up.
  
  

High-Yield Stock

• Not all companies can issue bonds at prevailing market rates. This is because some bonds are issued by companies considered riskier than others. For instance, General Electric probably can issue bonds at a lower rate than a penny stock that has only been in operation for six months. Bonds with a high interest rate are considered to be high-yield stocks. High-yield is synonymous with high risk.