Preferred stock is classified as a fixed-income security because its yearly payment is stipulated as either a coupon (for example, 5 percent of the face value) or a stated dollar amount (for example, $5 preferred). Preferred stock differs from bonds because its payment is a dividend and therefore not legally binding. For each period, the firm’s board of directors must vote to pay it, similar to a common stock dividend.
Even if the firm earned enough money to pay the preferred stock dividend, the board of directors could theoretically vote to withhold it. Because most preferred stock is cumulative, the unpaid dividends would accumulate to be paid in full at a later time.
Although preferred dividends are not legally binding, as are the interest payments on a bond, they are considered practically binding because of the credit implications of a missed dividend. Because corporations can exclude 80 percent of intercompany dividends from taxable income, preferred stocks have become attractive investments for financial corporations.
For example, a corporation that owns preferred stock of another firm and receives $100 in dividends can exclude 80 percent of this amount and pay taxes on only 20 percent of it ($20). Assuming a 40 percent tax rate, the tax would only be $8 or 8 percent versus 40 percent on other investment income. Due to this tax benefit, the yield on high-grade preferred stock is typically lower than that on high-grade bonds.
As noted earlier, more than half of all fixed-income securities available to U.S. investors are issued by firms in countries outside the United States. Investors identify these securities in different ways: by the country or city of the issuer (for example, United States, United Kingdom, Japan); by the location of the primary trading market (for example, United States, London); by the home country of the major buyers; and by the currency in which the securities are denominated (for example, dollars, yen, pounds sterling). We identify foreign bonds by their country of origin and include these other differences in each description.
A Eurobond is an international bond denominated in a currency not native to the country where it is issued. Specific kinds of Eurobonds include Eurodollar bonds, Euroyen bonds, Eurodeutschemark bonds, and Eurosterling bonds. A Eurodollar bond is denominated in U.S. dollars and sold outside the United States to non-U.S. investors. A specific example would be a U.S. dollar bond issued by General Motors and sold in London.
Eurobonds are typically issued in Europe, with the major concentration in London. Eurobonds can also be denominated in yen. For example, Nippon Steel can issue Euroyen bonds for sale in London. Also, if it appears that investors are looking for foreign currency bonds, a U.S. corporation can issue a Euroyen bond in London.
Yankee bonds are sold in the United States, denominated in U.S. dollars, but issued by foreign corporations or governments. This allows a U.S. citizen to buy the bond of a foreign firm or government but receive all payments in U.S. dollars, eliminating exchange rate risk.
An example would be a U.S. dollar–denominated bond issued by British Airways. Similar bonds are issued in other countries, including the Bulldog Market, which involves British sterling–denominated bonds issued in the United Kingdom by non-British firms, or the Samurai Market, which involves yen-denominated bonds issued in Japan by non-Japanese firms.
International domestic bonds are sold by an issuer within its own country in that country’s currency. An example would be a bond sold by Nippon Steel in Japan denominated in yen. A U.S. investor acquiring such a bond would receive maximum diversification but would incur exchange rate risk.
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