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What Income Investors Should Know

Below we provide information on a variety of subjects involving income investing that should be of interest to both newer income investors and very possibly to experienced investors. If you have any comments about the information below or any other similar questions about income investing, please email us via our Feedback form or directly to comments@quantumonline.com and we will happy to add them to this page.

Preferred Ticker Symbols and Names  
If you haven't already read the information on our Preferred Ticker Symbols and Names page, please do. It will save us both a lot of questions and problems in the long run.

What Happens in a Bankruptcy?
The SEC has done an excellent job of explaining what happens to a company and their investors during a corporate bankruptcy. To see the SEC's discussion on their website, click on the underlined What Every Investor Should Know about Corporate Bankruptcy.

What is the yield of a preferred stock?
What the yield is for a preferred stock can be confusing as it depends on circumstances. Let's consider the J.P. Morgan Chase Capital XIV 6.20% Capital Securities, Series N trust preferred (ticker symbol JPM-Y). The 6.20% value included in the security name is the Coupon Rate which is the same value included in the QuantumOnline tables and descriptions. The basic use of the coupon rate is to determine the annual distribution of a security. If you take the $25.00 Liquidation Preference of JPM-Y and multiply it by the 6.20% (0.062) you come up with the annual distribution for JPM-Y of $1.55 per year. Preferred stocks are a fixed income security. The term fixed income means the dividend distribution is fixed and will not vary while the security remains outstanding. In other words, JPM-Y will pay $1.55 per year and this payment will not vary while the security remains outstanding (unless the issuer decides to defer or not pay the dividend which they will not do without very serious consideration).

Another yield term you need to understand is Current Yield. While the dividend of a preferred remains fixed, the market price of a preferred stock does not. The current yield measures the yearly distribution of a security against the current market price. To determine the current yield, you divide the fixed yearly dividend by the current market price and multiply by 100 to get the current yield in percent. For example, if JPM-Y is selling for $27 the current yield would be 5.74% ($1.55 divided by $27 times 100). At a market price of $23, the current yield would be 6.74% ($1.55 divided by $23 times 100). The primary value of current yield is to indicate that your actual yield in percent from your investment in a preferred stock actually depends on the current market price.

Three other yields involved with preferreds and other fixed income securities are Yield to Call (YTC), Yield to Maturity (YTM) and Yield to Worst (YTW). You can click on the underlined terms above to see our glossary definitions for these terms. These are terms that are of importance to sophisticated investors looking to get every penny of income from their investments. For the less sophisticated investor, you might just remember that if the current market price of a security is above the liquidation preference of a security your long term actual yield will be slightly less than the current yield while if the market price is below the liquidation preference, the actual yield will be slightly above the current yield.

QuantumOnline does plan of offering Yield to Call (YTC) and Yield to Maturity (YTM) information in the future but at this point we can't say exactly when it will be. In our case, we first have to find a source of affordable current price quotes that we can use on the website and as the basis of the YTC & YTM calculations before we can even begin the programming on the yield information. We also have to find some good formulas for making the yield calculations that do not unduly slow down the loading of our tables.

We also do not know of any other website that offers YTC and YTM information or even YTC and YTM calculators. One suggestion we have in this regard is that some of the Financial Calculators (Hewlett-Packard, Texas Instruments, etc.) do offer YTC and/or YTM calculations. A second suggestion is that it is our understanding that Excel spreadsheets also offer YTC and/or YTM calculations but we have never attempted to confirm this ourselves.

What is the Call Date (or redemption date)?
The term redemption date is used in IPO prospectuses while the common usage in the security industry is the Call Date which is just another name for the redemption date. The redemption date (which is normally set at 5 years from the date of issue on newer preferreds) is the date when the company has the OPTION to redeem (or call) the preferred - if they want to. The redemption date is virtually always specified as the date "on or after" which the company can redeem but is not required to redeem the preferred stock. Once the call date has passed, the company may call the security at any time at their option. If they do redeem the preferred, they will do it at the redemption amount specified in the IPO prospectus issued when the stock was first sold. Recently most preferreds have been issued with a redemption (or call) price equal to the liquidation preference (issue price). In other words, a preferred issued at $25 would be redeemed (called) at $25, no matter what the market price of the preferred is prior to the redemption or call date.

I would definitely recommend that any new investor go to our Preferred Stocks table, pick out a preferred that might interest you, and click on the "Prospectus" link provided on most recent preferreds. You don't have to read the entire prospectus (that generally runs 50 to 100 pages) but looking over the first five or ten pages and studying the section that gives a summary of the provisions of the new preferred issue would be time well spent. You might also just glance over the remainder of the prospectus to see what other information is provided which is often mainly boiler plate.

What happens when a preferred stock matures?
Specifically, what happens when a preferred stock matures is exactly what the IPO prospectus said would happen at maturity. In virtually all cases, what happens is that the liquidation preference amount (generally equal to the original purchase price paid at the IPO), plus any accrued and unpaid dividends, is returned to the holder of the security. Note that the amount returned has NOTHING to do with the market price prior to maturity date. The holder of the security will normally be paid the specified liquidation preference at maturity.

This is where the term "yield to maturity" comes in. For example, let's take an 8%, $25 (liquidation value) preferred stock which is selling for $26.00 one year before maturity. The preferred will pay 8% or $2.00 during its final year and then will pay the holder $25. Overall, the preferred will pay $2.00 in dividends but lose $1.00 in value during the year for a yield to maturity of 4%. The same preferred selling for $24 one year before maturity would pay $2.00 in dividends, gain $1.00 in value and would have a yield to maturity of 12%. Tax considerations can effect these calculations but are a separate issue.

What is the ex-dividend date?

The source of this explanation is the SEC website at: http://www.sec.gov/answers/dividen.htm

Have you ever bought a stock only to find out later that you were not entitled to the next cash or stock dividend paid by the company? To determine whether you should get cash and most stock dividends, you need to look at two important dates. They are the "record date" or "date of record" and the "ex-dividend date" or "ex-date."

When a company declares a dividend, it sets a record date when you must be on the company's books as a shareholder to receive the dividend. Companies also use this date to determine who is sent proxy statements, financial reports, and other information.

Once the company sets the record date, the stock exchanges or the National Association of Securities Dealers, Inc. fix the ex-dividend date. The ex-dividend date is normally set for stocks two business days before the record date. If the record day is not a business day when the stock markets are open, the ex-dividend date is set from the first business day prior to the record date. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend. If you purchase before the ex-dividend date, you get the dividend.

Here is an example:

On July 27, 2002, Company XYZ declares a dividend payable on September 10, 2002 to its shareholders. XYZ also announces that shareholders of record on the company's books on or before August 10, 2002 are entitled to the dividend. The stock would then go ex-dividend two business days before the record date.

In this example, the record date falls on a Tuesday. Excluding weekends and holidays, the ex-dividend is set two business days before the record date or the opening of the market – in this case on the preceding Friday. This means anyone who bought the stock on Friday or after would not get the dividend. At the same time, those who purchase before the ex-dividend date receive the dividend.

With a significant dividend, the price of a stock may move up by the dollar amount of the dividend as the ex-dividend date approaches and then fall by that amount after the ex-dividend date. A stock that has gone ex-dividend is marked with an "x" in newspapers on that day.

Sometimes a company pays a dividend in the form of stock rather than cash. The stock dividend may be additional shares in the company or in a subsidiary being spun off. The procedures for stock dividends may be different from cash dividends. The ex-dividend date is set the first business day after the stock dividend is paid (and is also after the record date).

If you sell your stock before the ex-dividend date, you are also selling away your right to the stock dividend. This is the case even if the sale took place after the record date. When this happens, your sale includes an obligation on your part to deliver to the buyer of your shares any additional shares because of the dividend. Thus, it is important to remember that the day you can sell your shares without being obligated to deliver the additional shares is not the first business day after the record date, but usually is the first business day after the stock dividend is paid.

What Investment Risks are involved in Preferred Stocks?
Art LaPella, a QOL user and supporter, has done an excellent job of explaining what investment risks are involved with preferred stocks and other income securities. To see Art's discussion on this subject, click on the underlined Income Investing Risks.

Why do some preferreds start trading on the Other OTC instead of the NYSE?
First, if you do not understand what the Other OTC trading venue is, see our definition of it on our Glossary of Income Investing Terms.

Many issues that will trade on the NYSE actually begin trading on the Other OTC. Trading on the Other OTC is an interim trading venue between the date the securities are issued and the date when they actually begin trading on the NYSE. When a new preferred is issued, you will find a statement equivalent to the following in its prospectus: "We plan to list the Preferred Securities on the New York Stock Exchange. We expect that the Preferred Securities will begin trading on the New York Stock Exchange within 30 days after they are first issued." In reality, the new securities will begin trading on the NYSE in anywhere between a few days to, infrequently, as much as 60 to 90 days.

During this interval, many securities will trade on the Other OTC. At this time you may be able to buy the new preferred but the availability is not guaranteed. The preferred may be available for purchase at a reasonable price or it may not. The availability and the market price is definitely a factor of supply and demand. If you are interested in purchasing a security during this interval, you should use limit price orders and not be surprised if you are not able to buy the security. Most brokers should be able to handle orders for these securities online but you should check with your brokerage firm to be sure. If you do purchase a security on the Other OTC, the ticker symbol should be converted to the NYSE symbol as soon as the security starts trading on the NYSE but you may have to prompt your brokerage firm to do it if it does not happen automatically.

Why are some issues trading on the Other OTC, the OTCBB or the Pink Sheets, instead of the NYSE?
There are a variety of reasons for issues to trade on the Other OTC (OTOTC), the OTCBB or the Pink Sheets (PKSHT). A few of the issues actually start trading on these trading venues. Generally these are issues where the common stock also trades on the venue. A number of preferred issues move to the venues when most of the original shares have been redeemed or repurchased by the company and only a limited number of shares remain outstanding. A number of issues that trade on the Other OTC, OTCBB or Pink Sheets start out as private placements and then start trading on these alternate exchanges when the original purchasers want to sell some or all of their shares. Other preferreds wind up on these alternate venues after suspending their distributions or going into bankruptcy.

When shares are trading on the Other OTC or the Pink Sheets in particular, it can be difficult or impossible to actually purchase shares that are being quoted or, at least, to purchase them at a reasonable price. Placing a market order to buy or sell these securities would generally be a bad idea as the execution price could be considerably different than the latest quote. The only thing a purchaser can do is put in a bid and see if they can buy the shares.

QuantumOnline includes the Other OTC, OTCBB and Pink Sheets issues in our listings for the sake of completeness and because if we do not, we will hear from our website users about the existence of these issues. Many of the issues quoted on these alternate exchanges can be good and safe investments if the purchaser can actually buy the security. The purchase of other issues will be speculations as to whether the issuer will resume distributions, come out of bankruptcy successfully, etc. All-in-all, with the Other OTC, OTCBB and Pink Sheet securities, as with all other securities, the potential purchaser should do their homework before actually committing themselves to a purchase.

What are the federal tax withholding provisions for U.S. securities held by individual Nonresident Aliens?
Payment of principal and interest on U.S. capital securities held by individual investors is subject to the 30% U.S. federal withholding tax unless the nonresident alien provides the company with a properly executed (1) IRS Form W-8BEN (or other applicable form) claiming an exemption from, or reduction in the rate of, withholding under the benefit of an applicable tax treaty between the U.S. and the alien's country or (2) IRS Form W-8ECI (or successor form) stating that interest paid on the capital securities (is not subject to withholding tax because it is effectively connected with your conduct of a trade or business in the United States.

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