Risks of Preferred Stocks

• Preferred stock is a class of equity that is a hybrid between corporate bonds and common stock. Preferred stock is not as safe as bonds because bondholders are paid before preferred stock in the event of a company's failure. However, according to Investorwords.com, preferred stock is safer than common stock in that preferred takes precedence over common should the company be liquidated. Although preferred stock is safer than common stock, it still entails significant risks.
  
  

Interest Rate Risk

• Preferred stocks pay a fixed interest rate in the form of a dividend. If interest rates within the overall economy rise, then the value of preferred stocks declines. Owning a preferred stock locks you into the interest rate being paid at the time of the purchase of the preferred stock. If you feel that interest rates will be going up in the future, then you are better off selecting investments prone to appreciate in a rising interest rate environment as opposed to preferred stocks that depreciate in this scenario.
  
  

Company Failure

• There is always a risk of corporate failure emanating from general market conditions, company mismanagement or corporate fraud. Corporate bondholders are the first to be paid if a company fails. For this reason, corporate bonds pay less interest as compared to preferred stocks. If you own preferred stock in a bankrupt company, then there is substantial risk that upon liquidation of the company's assets there will be nothing left after paying corporate bondholders. This scenario results in both common and preferred stock owners suffering a complete loss of their investments.
  
  

Coercive Tenders

• During times of duress, companies have been known to threaten their preferred stock holders with cancellation of all dividends and liquidation preference rights. According to Barron's, Citigroup employed this type of coercive tender in 2009 thus forcing the preferred stock owners to swap their holdings for less secure common stock.