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

Which security allows the investor to "buy" shares of the company's common stock at a set price?

1. Convertible preferred stock

2. Participating preferred stock

3. Cumulative preferred stock

4. Non-cumulative preferred stock

The correct answer is: Convertible preferred stock

The correct answer is convertible preferred stock because this type of security provides investors with the option to convert their preferred shares into a predetermined number of common shares at a set price. The conversion feature allows investors to take advantage of potential appreciation in the value of the common stock while providing them with the benefits of preferred stock, such as fixed dividends and priority in asset liquidation. Convertible preferred stock essentially acts as a hybrid security, combining characteristics of both equity and debt. Investors are often drawn to this option because it offers the potential for capital gains if the company's performance leads to an increase in common stock value. Additionally, during periods of low performance, holders still receive their fixed dividends, offering some downside protection. In contrast, the other types of preferred stock mentioned do not carry the conversion feature. Participating preferred stock does allow shareholders to participate in additional dividends beyond the fixed rate but does not provide a conversion option to common stock. Cumulative and non-cumulative preferred stocks pertain to dividend payments and their accumulation but do not allow for an exchange into common stock. Therefore, the key advantage of convertible preferred stock is the flexibility it offers to investors, allowing them to "buy" into common stock if they believe the company is likely to perform well.