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Preferred Stock vs Bonds: Two Different Claims on the Same Company
Both can pay a fixed, scheduled amount. Only one of them is legally required to.
Preferred stock and bonds can look alike on the surface: both often pay a fixed amount on a set schedule, and both usually rank ahead of common stock if a company runs into trouble. The resemblance stops at the legal foundation. A bond is a debt instrument, a contractual promise to pay interest and, at maturity, principal, that the issuer must honor or default. Preferred stock is an equity instrument, a class of ownership shares whose dividend must be declared by the company's board before it is owed at all, and which typically carries no maturity date and no promised return of principal.
Direct Answer
A bond is a contractual debt claim: the issuer owes the bondholder scheduled interest and, at a stated maturity date, repayment of principal, and skipping either is generally a default. Preferred stock is an equity claim: the holder owns a class of shares entitled to a dividend, but that dividend must be declared by the board before it is owed, there is usually no maturity date, and skipping it is not a default. In a bankruptcy or liquidation, bondholders are generally paid before preferred shareholders, who are generally paid before common shareholders, so the two instruments sit at different, fixed points in the same company's capital structure rather than competing for the identical claim.
Why This Comparison Is Easy to Get Wrong
Preferred stock earns the nickname "hybrid security" for a reason: a typical preferred issue pays a fixed, stated dividend rate on a regular schedule, in a dollar amount that looks and behaves a great deal like a bond coupon. Its price also moves with interest rates in roughly the same direction a bond's price does. Those similarities lead a lot of people to treat preferred stock as a slightly riskier flavor of bond, and that is the part that is wrong. Preferred stock is legally equity. The company's board decides whether to declare its dividend, in the same way a board decides whether to declare a common stock dividend, and choosing not to declare a preferred dividend is not a default the way missing a bond's interest payment is. The two instruments can pay an identical dollar amount on an identical date and still carry a fundamentally different legal promise behind that payment.
Side-by-Side Comparison
The table below compares the two instruments by structural mechanic, how each is classified, how each payment is owed, and where each sits if a company runs into trouble, rather than by current yield, price or rating, which move too often to belong in a reference table.
| Dimension | Preferred stock | Bonds |
|---|---|---|
| What kind of claim it is | An equity ownership interest in the issuing company, represented by a class of shares. | A debt claim against the issuer, evidenced by a note or indenture. |
| Is the payment a legal obligation | No. The board must declare the dividend before it is owed; declining to declare it is not a default. | Yes. Interest is contractually owed on the schedule set in the bond's terms; missing a payment is generally a default. |
| Priority if the issuer fails | Paid from remaining assets after bondholders and other creditors, but generally ahead of common shareholders. | Paid from the issuer's assets before preferred and common shareholders receive anything. |
| Maturity structure | Typically perpetual, with no stated maturity date and no promised repayment of principal. | Issued with a maturity date set at issuance, at which the issuer repays face value. |
| How the price reacts to interest rates | Moves inversely with market rates, and because there is usually no maturity pulling the price back to a fixed value, the reaction can resemble a long-duration bond. | Moves inversely with market rates too, but the price is anchored back toward face value as the stated maturity date approaches. |
| How the payment is treated on the issuer's tax return | A dividend distributed from already-taxed corporate earnings; not a deductible business expense for the issuer. | Interest paid on indebtedness is deductible to the issuer under 26 U.S. Code Section 163(a). |
| Common optional features | May be callable by the issuer, convertible into common shares, and cumulative or non-cumulative with respect to skipped dividends. | May be callable by the issuer and, less commonly, convertible into common shares; neither feature is universal. |
How Preferred Stock Works
Preferred stock is a separate class of shares that sits between a company's debt and its common stock. According to the SEC's Office of Investor Education and Advocacy, preferred stockholders "usually don't have voting rights but they receive dividend payments before common stockholders do, and have priority over common stockholders if the company goes bankrupt and its assets are liquidated." Most preferred issues carry a stated dividend rate expressed against a par value, and, as FINRA describes it, that dividend "usually guarantees a fixed dividend payment similar to the coupon on a bond," paid out "before dividends on common stock." The word "guarantees" there describes the amount and priority of the payment relative to common stock, not a legal duty to pay it: the company's board still has to declare each dividend before it is actually owed to shareholders.
Two features determine what happens when a company decides not to declare a preferred dividend. Non-cumulative preferred stock simply forfeits a skipped dividend: it is gone, with no obligation to make it up later. Cumulative preferred stock instead lets unpaid dividends accumulate as "arrearages," which the company must pay in full before it can pay anything to common shareholders again. A cumulative feature is a real protection relative to common stock, but it is not a promise of eventual payment. If the company never resumes paying dividends, or fails while dividends remain suspended, the accumulated arrearage is simply an unpaid claim that ranks below the company's bonds and other debt, exactly like any other preferred claim in a liquidation.
Many preferred issues also carry a call feature, letting the issuer redeem the shares at a set price after a specified date, and some are convertible into a fixed number of common shares at the holder's option. The SEC's Investor.gov defines a convertible security as one, "usually a bond or a preferred stock, that can be converted into a different security," typically common stock, under terms fixed when the security was issued. Preferred stock most often trades on the same national securities exchanges as the issuer's common stock, under its own ticker, and FINRA notes that "the price of preferred stock... doesn't move as much as common stock prices," since its cash flow is more fixed-income-like even though its legal form is equity. See Swoopr's Convertible Securities guide for how the conversion mechanics work in more depth.
How Bonds Work
A bond is a debt security: the issuer borrows money from the bondholder and promises to repay it on specific terms. FINRA describes debt securities as "financial instruments that have defined terms between a borrower (the issuer) and a lender (the investor)." Those terms specify a coupon, the interest rate paid on the bond's face value, generally "paid out semiannually," and a maturity date, since "the vast majority of bonds have a maturity date that's set when the bond is issued," at which point "the borrower fulfills its debt obligation by paying bond holders the final interest payment and the bond's face value, called par value." Missing an interest or principal payment is generally an event of default, which gives bondholders contractual and, often, legal remedies that a preferred shareholder facing a suspended dividend does not have.
Bond prices move inversely with market interest rates: FINRA's summary is direct, "When interest rates rise, bond prices generally fall. When interest rates fall, bond prices generally rise. Every bond carries interest rate risk." Unlike preferred stock, a bond's price is anchored by its approaching maturity date: however far its price drifts from face value while rates and credit conditions change, it is scheduled to return to face value at maturity, assuming the issuer pays as promised. That anchor is exactly what preferred stock lacks, since a perpetual instrument has no future date pulling its price back toward a fixed number.
Callable bonds, which let the issuer retire the bond before it matures, are common too, and FINRA notes this creates "call risk," the chance that a bond gets redeemed earlier than an investor expected, typically when rates have fallen and the issuer can refinance more cheaply. Bond credit quality is also evaluated by "nationally recognized statistical rating organizations," and most corporate bonds "trade in the over-the-counter (OTC) market" through bond dealers rather than on a stock exchange, a structural contrast with preferred stock's typical exchange listing. See Swoopr's Bond Basics guide and Corporate Bonds guide for the mechanics of coupon structure, credit ratings and the OTC bond market in full.
Where Priority Actually Comes From
The ranking that separates these two instruments is not a matter of opinion or of one being generically "safer." It comes directly from what each claim legally is. A bond is debt, and creditors are paid from a company's remaining assets before any shareholder, preferred or common, sees anything. FINRA states the order plainly: if the company fails, obligations "to preferred stockholders must be met before those to common stockholders," while "preferred stockholders are lower on the list than bondholders." Preferred stock ranks where it does because it is still equity, an ownership claim on whatever is left, just a class of ownership with a contractually defined dividend preference and liquidation preference over the common shares below it.
That ranking has a knock-on effect on credit evaluation. Because a preferred issue sits below the same company's bonds in the capital structure, a credit rating agency evaluating the two will generally assign the preferred stock a lower rating than the company's senior bonds, reflecting that lower claim on the same set of assets rather than a difference in how the underlying business is performing. A single company in financial distress can therefore see its bonds, its preferred stock and its common stock all react very differently at the same time, exactly because each instrument is a different-ranked claim on the identical set of assets and earnings.
Worked Example: Why a Perpetual Payment Reacts Differently to Rates
The figures below are entirely illustrative, invented for this example to demonstrate the mechanism, not the terms of any real company's securities and not a claim about any current market rate or dividend rate. Assume a hypothetical company has outstanding a $25 par, non-cumulative preferred share paying an illustrative 6% stated annual dividend, or $1.50 per year, and, separately, a 10-year, $1,000 par bond paying an illustrative 6% annual coupon, or $60 per year. Both securities were priced to yield 6% at issuance, so both started at their respective par values.
| Security (illustrative) | Annual payment | Price at a 6.0% required yield | Price at a 7.5% required yield | Price change |
|---|---|---|---|---|
| $25 par preferred share, perpetual, no maturity | $1.50 | $25.00 (par) | $20.00 ($1.50 ÷ 0.075) | -20.0% |
| $1,000 par bond, 10 years to maturity | $60.00 | $1,000.00 (par) | Below par, but scheduled to return to $1,000 at maturity in 10 years regardless of the path rates take in between | Smaller and temporary |
The preferred share's illustrative price is calculated the way any perpetual, level payment is valued: price equals the annual payment divided by the required yield, with no future date at which that math stops applying. When the required yield rises from an illustrative 6.0% to an illustrative 7.5%, the price falls the full 20% implied by that formula and stays there for as long as the higher yield persists, because nothing about the security ever forces its price back toward $25. The bond's price also falls when rates rise, but every year that passes shortens the remaining time to its maturity date, and the bond is contractually scheduled to be worth exactly $1,000 again when that date arrives, assuming the issuer pays as promised. The same size interest rate move produces a full, permanent-until-rates-reverse price swing on the perpetual instrument and a partial, temporary one on the instrument with a maturity date. That is the mechanism behind calling preferred stock's rate sensitivity "bond-like but with no floor," and it follows directly from the maturity difference in the comparison table above, not from any assumption about which security is bigger or safer.
Which Fits Which Situation
An investor who specifically wants a date on which principal is scheduled to come back, so the money can be redeployed or spent, generally finds a bond with a defined maturity fits that need more directly, since most preferred stock has no such date and no promise that principal is ever returned, short of the issuer choosing to exercise a call.
An investor whose priority is the strongest available legal claim on a specific company if that company runs into trouble generally finds that company's bonds sit ahead of its preferred stock in the payment order, all else equal, since preferred stock's protection is a dividend and liquidation preference over common stock, not a creditor's claim.
An investor who wants a security that trades on a stock exchange during regular market hours, the way other equities do, may find preferred stock's typical exchange listing more familiar to trade than working through a bond dealer in the primarily over-the-counter bond market, though FINRA's TRACE system does publish real-time bond pricing data for many issues.
An investor evaluating either instrument for its call risk needs to check the specific issue's terms either way, since both preferred stock and bonds are commonly issued callable, and the presence or absence of that feature depends on the security's own documentation, not on whether it is labeled preferred stock or a bond.
An investor concerned with how the payment is taxed to them as a holder should note that preferred dividends and bond interest are frequently taxed differently to an individual investor, and should consult Swoopr's dedicated Qualified vs. Ordinary Dividend Taxation guide rather than assume either instrument's income is taxed the same way as the other.
None of this is a recommendation of either instrument, or of any specific bond or preferred share. Which fits a given portfolio depends on what claim, priority and payment structure the investor is actually trying to add, and on the specific issuer's financial condition, not on a general rule that one instrument type is better than the other.
Common Myths and Misconceptions
- "Preferred stock dividends are guaranteed, like bond interest." They are not. A company's board must declare a preferred dividend before it is owed, and can decline to declare it without that being a default, unlike missing a bond's contractual interest payment.
- "Preferred stock is basically just a slightly riskier bond." It is legally equity, not debt. The similarity in payment schedule and dollar amount does not change that preferred shareholders have no creditor's claim and rank below bondholders if the company fails.
- "Cumulative preferred stock means I'll eventually get paid." A cumulative feature only guarantees that skipped dividends must be paid before any dividend reaches common shareholders once the board resumes distributions. It does not force the board to resume distributions at all, and an unpaid arrearage is worth nothing if the company fails while dividends remain suspended.
- "It's called 'preferred,' so it must be safer than common stock in every sense." Preferred stock does carry a dividend and liquidation preference over common stock, but it still ranks below all of the company's bonds and other debt, so it is not safe in an absolute sense, only relative to the common shares beneath it.
- "Preferred stock has a maturity date like a bond, so I'll get my money back on a set schedule." Most preferred stock is perpetual with no stated maturity date at all. Any return of principal generally depends on the issuer choosing to exercise a call, which is the issuer's option, not the holder's right.
- "Skipping a preferred dividend is a default, the same as missing bond interest." It is not. Missing bond interest is generally an event of default with contractual remedies for bondholders. Declining to declare a preferred dividend is a board decision within the preferred stock's own terms, not a default under the security.
FAQ
What is the main difference between preferred stock and a bond?
A bond is a debt instrument: the issuer contractually owes the bondholder interest and, at maturity, repayment of principal, and missing those payments is generally a default with legal remedies for the lender. Preferred stock is an equity instrument: the holder owns a class of shares entitled to a dividend the company's board must declare before it can be paid, and there is usually no maturity date on which principal comes due at all.
Do preferred stock dividends work like bond interest?
They resemble each other in size and regularity, since many preferred issues carry a fixed, stated dividend rate paid on a set schedule, similar in form to a bond coupon. The legal character is different: bond interest is a contractual obligation of the issuer, while a preferred dividend must be declared by the board before it is owed, which is why a company can suspend a preferred dividend without triggering a default the way skipping bond interest would.
What happens to preferred stock and bonds if a company goes bankrupt?
Bondholders and other creditors are generally paid from the company's remaining assets before preferred shareholders receive anything, and preferred shareholders are generally paid before common shareholders. This order reflects each instrument's position in the capital structure, and it applies whether or not a preferred dividend was cumulative, since unpaid cumulative dividends are simply another claim that ranks below the company's debt.
Can preferred stock be converted into common stock?
Some preferred stock is convertible, meaning the holder, or in some structures the company, can exchange it for a set number of common shares under terms fixed when the preferred stock was issued. Convertible bonds work the same way on the debt side. Not every preferred issue or bond is convertible; the feature exists only when the issuing terms specifically include it.
Are preferred dividends guaranteed?
No. A preferred dividend is not guaranteed even when it is described as cumulative. A cumulative feature only requires unpaid dividends to accumulate and be paid before any dividend can go to common shareholders once the board resumes distributions; it does not force the board to declare a dividend in the first place, and if the company fails while dividends are suspended, accumulated but unpaid preferred dividends rank below the company's debt like any other unpaid preferred claim.
Why is preferred stock sometimes called a hybrid security?
Because it combines features of both categories. Like a bond, it commonly pays a fixed, scheduled amount and its price reacts to changes in market interest rates. Like common stock, it is a form of equity ownership, usually carries no maturity date, and its payment is not a legal debt obligation the way bond interest is. Neither label fully describes it, which is exactly why the comparison in this guide focuses on mechanics rather than a single category name.
Does preferred stock have a maturity date like a bond?
Most preferred stock is perpetual, meaning it has no stated maturity date and no promised date on which the company returns principal, unlike the vast majority of bonds, which are issued with a maturity date set when the bond is issued. Some preferred issues carry call features that let the issuer redeem the shares at its own option, but that is a choice reserved to the issuer, not a right the holder can force, and it is different from a bond's scheduled repayment at maturity.
Is preferred stock riskier than the same company's bonds?
Generally yes, from the standpoint of payment priority, since preferred stock ranks below the same issuer's bonds and other debt in a bankruptcy or liquidation, and its dividend can be suspended at the board's discretion without constituting a default. That said, risk also depends on the specific bond and the specific preferred issue, their call and conversion terms, and the issuer's overall financial condition, so the general priority ranking is a starting point for analysis, not a complete risk assessment on its own.
Educational Use
This page is educational and informational. It does not tell a reader what to buy, sell, hold or contribute, and it does not account for an individual's objectives, taxes, legal situation, benefits, debts, time horizon or risk tolerance. Specific issue terms, tax treatment, credit ratings and market prices change and vary by security; verify current terms and figures for any specific preferred share or bond from its own prospectus or offering documents and from the primary sources cited below before acting.
References
- SEC Investor.gov: Stocks, Preferred vs. Common Stock
- FINRA: Stocks, Key Concepts
- FINRA: Bonds, Key Concepts
- SEC Investor.gov: Convertible Securities
- SEC Investor.gov: Bonds or Fixed Income Products
- Office of the Law Revision Counsel: 26 U.S. Code Section 163, Interest
This content was reviewed by the Swoopr Editorial Team in August 2026 and reflects publicly available information at that time.