Canadian Securities Course (CSC) Level 2 Practice Exam

What is the main consideration for determining the investment quality of preferred shares according to the text?

1. Current stock price volatility

2. Market capitalization

3. Conversion options

4. Does the earnings cover dividends?

The correct answer is: Does the earnings cover dividends?

The main consideration for determining the investment quality of preferred shares is indeed whether the earnings cover dividends. This is crucial because preferred shares are designed to pay dividends before any payments are made to common shareholders. The ability of a company to generate sufficient earnings to cover these dividends indicates the financial health of the company and its capacity to provide consistent returns to preferred shareholders. When earnings reliably exceed the dividend obligations, it signifies a stable company that can meet its financial commitments. This consideration plays a central role in assessing the risk associated with investing in preferred shares. A company that struggles to cover its dividend payments may be seen as a riskier investment, potentially leading to a decrease in the preferred shares' value and jeopardizing the investment. While factors such as current stock price volatility, market capitalization, and conversion options can influence preferred shares' market appeal, they do not directly address the core concern of whether the company can sustain its dividend commitments. Thus, assessing earnings relative to dividends is fundamental in evaluating the investment quality of preferred shares.