Preferred stock is somewhere between debt and equity in terms of payment attributes and tax considerations. Preferred stock mimics debt in the principal and interest payment. However, it acts more like equity in that there is no guarantee on the repayment of principal and interest payments are treated like dividends for tax purposes. The nominal rate of return is commonly used to compare preferred stock programs against bonds that receive a tax incentive through interest payments.
Instructions
1. Review the definition of nominal. Nominal is the term often used to refer to "current" or "unadjusted" when used in conjunction with rates. For instance, a tax-free rate or an inflation-adjusted rate versus a nominal rate. The nominal rate is always the easiest rate to calculate even though it may not be the most accurate or meaningful.
2. Work through an example. Let's say you purchase preferred stock that pays a quarterly dividend of $3. If the price of the preferred stock is $100, calculate the nominal rate of return.
3. Review the formula. The calculation is "annual dividend (quarterly dividend * price)/ price" = $3*4)/$100 = $12 / $100 = .12 or 12 percent. The nominal rate of return is 12 percent.
