Definition
The term auction rate preferred stock refers to securities with interest rates that are reset through auctions. Oftentimes issued by closed-end funds, auction rate preferred stock typically have their interest rate reset on a schedule that ranges from fourteen days to seven weeks.
Explanation
Also known as auction market preferred stock (AMPS), the rate of interest paid to holders of auction rate preferred stock can vary over time. A third party provider is typically used to oversee the auction process. The results of the auction were of importance to investors at one time, since the interest rate achieved through this process could be used to help predict the yields of similar securities. Investors that wish to insulate themselves from the effects of inflation also value these securities.
If there is insufficient investor interest in an auction to purchase all shares of the security, a failed auction is said to occur. When this happens, the rate of interest paid is usually set to the maximum allowable rate as originally defined by the issuer.
Historically, underwriters would participate in the auction to prevent it from failing. However, following the financial crisis of 2007, underwriters pulled back from this market in 2008. Eventually, the Securities and Exchange Commission would conclude a number of firms violated the Securities Act of 1933. Specifically, it found there were material misstatements and omissions during the offer / sale of these securities to investors.
Related Terms
The term convertible exchangeable preferred stock refers to a security that allows the issuer to exchange it for convertible bonds. Empirical evidence suggests issuing convertible exchangeable preferred stock is oftentimes accompanied by a negative earnings outlook.
Moneyzine EditorJanuary 12th, 2024- The term participating convertible preferred stock refers to a security commonly issued as part of venture capital financing. Participating convertible preferred stock provides the holder with the rights to both dividends as well as a conversion feature.Moneyzine EditorSeptember 20th, 2023
The term convertible adjustable preferred stock refers to a floating rate security with an interest rate that is indexed to Treasury securities. Convertible adjustable preferred stock can be converted by the holder on the dividend payment date.Moneyzine EditorJanuary 12th, 2024- The term preferred equity redemption stock refers to a security that features a mandatory conversion at maturity. Preferred equity redemption stock (PERC) can also be redeemed early by the issuing entity, but at a premium.Moneyzine EditorSeptember 21st, 2023
