Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What characterizes participating preferred stock?

1. It does not allow for dividend increases.

2. It allows investors to participate in additional earnings.

3. It has a fixed dividend rate.

4. It is not convertible into common stock.

The correct answer is: It allows investors to participate in additional earnings.

Participating preferred stock is characterized by its ability to allow investors to participate in additional earnings beyond the fixed dividends. This means that in profitable times, if the company performs well and declares dividends beyond the standard preferred dividend rate, holders of participating preferred stock can receive not just their fixed dividend but also an additional dividend that is allocated to them based on the company's profit-sharing structure. This feature provides an opportunity for enhanced returns compared to regular preferred stock, which typically offers only a fixed dividend without the potential for additional earnings participation. In contrast, the other options describe characteristics that do not align with participating preferred stock. For instance, stating that it does not allow for dividend increases contradicts the very nature of participation in earnings. Similarly, a fixed dividend rate applies to many types of preferred stock, but the unique aspect of participating preferred stock is its potential for additional dividends beyond that fixed rate. Lastly, the ability to convert into common stock is irrelevant for the definition of participating preferred stock, as this feature pertains to convertible preferred stock rather than the participation aspect.