Certified Anti-Money Laundering Specialist Certification (CAMS) Practice Exam

What type of preferred stock allows the holder to convert it into common stock?

1. Convertible Preferred

2. Non-Convertible Preferred

3. Participating Preferred

4. Redeemable Preferred

The correct answer is: Convertible Preferred

Convertible preferred stock is a specific type of preferred stock that provides the holder with the option to convert their shares into a predetermined number of common stock shares, usually at a specified time and under certain conditions. This feature allows investors to benefit from potential appreciation in the common stock’s value while also enjoying the fixed dividends associated with preferred shares. The ability to convert enhances the appeal of the investment, as it offers both debt-like characteristics (through fixed dividends) and equity-like upside potential. In contrast, non-convertible preferred stock does not offer this conversion feature, limiting the holder to fixed dividends without the opportunity to gain from any rise in the common stock's market value. Participating preferred stock allows holders to receive additional dividends based on the company's earnings and may also provide some conversion rights, but it is primarily focused on dividend distribution rather than conversion to common stock. Redeemable preferred stock is structured so that the issuing company can buy back the shares at a predetermined price, which does not inherently provide the same conversion capability as convertible preferred stock. Thus, convertible preferred stock stands out due to its dual advantage of fixed income and potential equity participation.