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

What type of preferred stock must have missed dividends paid before other dividends can be paid?

1. Cumulative preferred stock

2. Convertible preferred stock

3. Participating preferred stock

4. Non-cumulative preferred stock

The correct answer is: Cumulative preferred stock

Cumulative preferred stock is a type of preferred stock that ensures that if a company has missed any dividend payments in previous periods, those unpaid dividends must be paid to cumulative preferred stockholders before any dividends can be distributed to common stockholders or dividends can be paid to other classes of preferred stock. This characteristic provides a safeguard to investors, as it means they will eventually receive all of their dividends—even if the company experiences financial difficulties in some years that prevent it from making payments. In contrast, the other types of preferred stock do not have this guarantee. For instance, convertible preferred stock allows shareholders to convert their shares into common stock but does not provide assurance regarding missed dividends. Participating preferred stock might allow holders to receive additional dividends beyond the stated rate if the company performs well, but it does not afford the same priority for missed payments as cumulative preferred stock. Non-cumulative preferred stock, on the other hand, does not accumulate unpaid dividends; if dividends are missed in any year, they are simply forfeited, and the stockholder has no claim to them when the company resumes payments. Thus, cumulative preferred stock stands out for its protective feature regarding unpaid dividends.