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Definition: Preference Shares
Preference shares have a par value and offer fixed amount of dividends (like bonds) which must be paid before paying dividends on common stock. However, failure to pay preferred dividends doesn’t empower the shareholders to force the company into bankruptcy (like common stocks).
In short, preference shares are the types of shares which exhibit partly, the characteristics of both bonds and common shares.
The relationship between the value of preferred stock (Vps), preferred dividend (Dps) and the rate of return (rps) is given by –
e.g.) Suppose the amount of dividend paid by a company is $10 per year and the rate of return is 10%. The value of the preferred share is then $100.
Preferred shares can be cumulative or noncumulative. The dividends on cumulative preferred shares keep on accumulating year after year until they are finally paid which is not the case in case of noncumulative shares where dividends are paid at random and only after declaration.
Generally, preferred shares are issued for an indefinite period of time. However, some preferred shares have a limited life period. They are called Redeemable Preferred Shares.