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First student answer

1: What are the pros and cons of using preferred and convertible instruments as investments?

Preferred

Pros:

1. The capital raised by preferred stock belongs to equity capital, and there is usually no maturity date. After financing, the financial risk will not increase, but the financing ability will be enhanced.

2. Preferred shareholders generally have no voting rights, and ordinary shareholders will not be threatened.

3. The dividends of preferred stocks are usually fixed. During the period of rising income, it can “save” most of the profits for existing ordinary shareholders, which has a certain leverage effect.

Cons:

1. The cost of preferred stock financing is higher than that of bonds. This is because dividends are paid after tax and cannot be offset against pre-tax profits.

2. Some preferred stocks require sharing residual ownership of common stocks, it will dilute their earnings per share.

Convertible

Pros: 

1. It is conducive to stabilizing stock prices and reducing the dilution of earnings per share.

2. Lower funding costs

3. Reduce conflicts of interest in fundraising

4. Easy to raise funds

cons:

1. Lose the advantage of low-interest rates

2. the risk of rising stocks

3. financial risk

 

2: How would you use them to strengthen your portfolio?

In various portfolios composed of other financial products, I can add preferred and convertible instruments in an appropriate proportion, and use the advantages discussed above to get your portfolio to achieve the desired effect. Generally, they can be used to enrich the portfolio’s anti-risk ability, overall profit, or flexibility/ liquidity.

 

3: What situation would you use each one in? Why?

For example, if I'm investing in stocks and I think that common stocks can choose preferred instruments such as preferred stocks to reduce the risk of the entire portfolio and obtain stable returns. When investing in bonds, I can choose products such as convertible bonds to improve my portfolio’s revenue and flexibility. If I own a company and need to finance more low-cost capital, I'll choose to issue convertible bonds. If I want to keep the financial risk at a relatively low level and preparing to finance more debt, I'll choose to issue preferred stocks.

 

(Citation)

Advantages and disadvantages for preferred stock and normal stock? which one is better. Finance comments. (n.d.). https://www.wstimes.cn/article/160886.htm.

Smith, & zhang. (2013, September 16). How do ordinary individual investors invest in convertible bonds? Zhihu. https://www.zhihu.com/question/21659989.

Second student answer

1. Preferred stock 

Pros: reliability/predictability, fixed preferred dividend, priority over common stock meaning that preferred shareholders will get paid before common stockholders in the event of a bankruptcy.

Cons: preferred stockholders to not hold voting rights

Convertible

Pros: include lower coupon rate

Cons: higher risks of dilution/bankruptcy/liquidity

2. I would use both for diversification on my portfolio, as we talked about in question one, there are pros and cons to both.  Choosing a variety for your portfolio allows for customization upon deciding on risk.

3. I would choose preferred stock for the consistent annual dividends if I was interested in a steady income.  An example for choosing convertibles would be to add the diversification to my portfolio with a chance for higher returns.