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You wrote, One item I have on my sheet currently is the number of distribution payments the current price is over/under which leads to a question that's been hanging out there in my mind. I understand the (wise) advice to not buy above par (but the advice on buying low and selling hi...that one still escapes me...) However, if I purchase a pfd above par but recoup that overage in distributions, what is the concern? As an example...yesterday, PSA-G was at $25.20 (0.80% above par) with a current yield of 6.94%. That is 0.46 payments above par. If I bought 100 shares at $25.20= $2520 invested. In the first distribution, I would receive $43.75 ($1.75 ann distribution/4*100 shares). If PSA called (@ $25.00/share) that security following the first and only distribution I received, I would lose $0.20/share ($20.00) on the call but will have netted $23.75 by adding back the distribution. To me, the apparent danger is the issue of being called before receiving a distribution. Is there another danger I am not seeing?

No, I think you're getting it. The problem is known as call risk. (Same problem exists in corporate and muni bonds.)

It's fine to buy a preferred that's above par that's non-callable. There you only have the usual risks such as default risk. Callable issues need a little extra caution.

For a callable preferred, it's best to calculate Yield-To-Worst (YTW). That tells you how much you stand to gain (or lose) if you buy this issue and it's called at the next (usually first) available date. This number tells you something about the call risk you're assuming.

And then there are the issues that are already callable. Those usually have undefined YTW returns because the issue could get redeemed tomorrow. However in some cases it might be worth investing in some of those because: 1) your analysis shows that they are not in a position today to call their debt; and 2) they are not so far above par that you are unlikely to recoup your entire invest by the time they do call this issue.

Ironically buying a callable issue from a highly rated company may present the most call risk. That's because highly rated companies are the most likely to exercise their call option.

But preferreds can muddy this otherwise clear piece of advice, because the underlying call warrants may not actually be owned by the company that issued the underlying debt. Instead, a 3rd party may own the warrants and they may choose to exercise them in order to profit from an arbitrage opportunity, rather than simply cashing them in to refinance the debt. (Had this happen to me with 2 Ford trust preferreds.)

- Joel
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