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

What type of preferred stock allows missed dividends to go into arrears?

1. Cumulative preferred stock

2. Non-cumulative preferred stock

3. Participating preferred stock

4. Convertible preferred stock

The correct answer is: Cumulative preferred stock

Cumulative preferred stock is the correct answer because this type of preferred stock requires that any unpaid or missed dividends accumulate and must be paid to the holders before any dividends can be distributed to common stockholders. If a company chooses not to pay dividends in a given year, those dividends do not disappear; instead, they accumulate as arrears. This protection for investors ensures they eventually receive all owed dividends, reinforcing the attractiveness of cumulative preferred stock to investors seeking reliable income. In contrast, non-cumulative preferred stock does not have this feature. If dividends are missed, they do not accumulate, and stockholders cannot claim them in future periods. Participating preferred stock allows holders to receive additional dividends beyond the fixed rate if the company performs exceptionally well, but it doesn't inherently provide a mechanism for missed dividends to be made up. Convertible preferred stock allows investors to convert their shares into common stock at a specified price, but like other forms of non-cumulative stock, it does not address the issue of accumulating unpaid dividends. Thus, cumulative preferred stock stands out as the option that secures the right to recover missed payments.