Overview
Foreign-pay preferred shares are a specialized type of preferred share issued by Canadian companies. Unlike most Canadian preferred shares that pay dividends in Canadian funds, foreign-pay preferred shares pay dividends in foreign currencies. These financial products come with unique benefits and risks that investors must consider before adding them to their portfolio.
What are Foreign-pay Preferred Shares?
Foreign-pay preferred shares are preferred shares of a Canadian company where dividends and sometimes other features are paid in foreign currencies instead of Canadian dollars. These shares are designed for investors who prefer to receive income in a foreign currency, possibly for diversification purposes or to meet other income needs in non-Canadian dollars.
Example:
Consider PQR, a Canadian company, issues 5.95% Non-cumulative Class B Series 10 shares that pay an annual dividend of US$1.4875.
Key Considerations
Desirability of Foreign Currency Dividends
The primary attraction of foreign-pay preferred shares is the receipt of dividends in a currency other than Canadian dollars. This feature can be beneficial for investors who expect the foreign currency to appreciate relative to the Canadian dollar.
Foreign Currency Risk
With foreign-pay preferred shares, there is an inherent risk associated with foreign currency fluctuations.
- If the foreign currency appreciates against the Canadian dollar, the value of the received dividends increases.
- Conversely, if the Canadian dollar appreciates against the foreign currency, the value of the dividends decreases when converted back to Canadian funds.
Tax Advantage
One notable advantage of foreign-pay preferred shares is that despite the dividend being in a foreign currency, because it is paid by a Canadian company, it is eligible for the dividend tax credit. This tax incentive can significantly increase the after-tax return on investment.
FAQ
Q1: What are the benefits of investing in foreign-pay preferred shares?
A1: The primary benefits include potential currency diversification, the opportunity to benefit from foreign currency appreciation, and eligibility for the dividend tax credit.
Q2: What risks are involved with foreign-pay preferred shares?
A2: The main risk is foreign currency risk, which can result in fluctuating dividend values when converted back to Canadian currency. There could also be additional complexities in managing foreign exchange transactions.
Q3: Are dividends from foreign-pay preferred shares eligible for the dividend tax credit?
A3: Yes, since these dividends are paid by a Canadian company, they qualify for the dividend tax credit.
Key Terms Glossary
- Foreign Currency Risk: The potential for losses due to adverse movements in exchange rates.
- Dividend Tax Credit: A non-refundable tax credit in Canada that reduces the income tax owed on dividends received from Canadian corporations.
- Preferred Shares: Type of share that gives shareholders a higher claim on assets and earnings than common shares, typically with fixed dividend payments.
Key Takeaways
- Diversification: Foreign-pay preferred shares provide a way to diversify income sources across different currencies.
- Income Stability: These shares promise regular dividend payments, although the value of those payments is subject to currency risk.
- Tax Efficiency: Dividends paid by Canadian companies are eligible for the dividend tax credit, even if paid in foreign currency.
- Currency Risk: Investors must be mindful of potential gains or losses due to fluctuations in foreign exchange rates.
Diagram: Foreign Currency Impact on Dividends
graph LR
A[Foreign-pay Preferred Share Issuance] --> B[Dividends in Foreign Currency]
B --> C[Convert to Canadian Dollars]
C --> D[Assessed in Canadian Funds]
style B fill:#f9f,stroke:#333,stroke-width:4px
Investors evaluating foreign-pay preferred shares need to weigh the potential benefits of currency diversification and dividend tax credits against the risks posed by fluctuating exchange rates. Proper analysis and alignment with investment goals are crucial for making informed decisions.
📚✨ Quiz Time! ✨📚
## What is a key characteristic of foreign-pay preferred shares compared to most Canadian preferred shares?
- [ ] They pay dividends in Canadian dollars
- [ ] They have higher credit ratings
- [ ] They are more easily subject to regulation
- [x] They pay dividends in foreign funds
> **Explanation:** Foreign-pay preferred shares are issued by Canadian companies but pay dividends in a foreign currency, which adds an element of foreign currency risk.
## What additional risk is associated with foreign-pay preferred shares?
- [ ] Liquidity risk
- [x] Foreign currency risk
- [ ] Inflation risk
- [ ] Credit default risk
> **Explanation:** Foreign-pay preferred shares carry foreign currency risk, as the value of dividends can fluctuate based on the exchange rate between the foreign currency and Canadian dollars.
## What happens to the value of dividends from foreign-pay preferred shares if the foreign currency appreciates relative to the Canadian dollar?
- [x] The dividend increases in value
- [ ] The dividend decreases in value
- [ ] The dividend value remains unaffected
- [ ] The dividend is converted to Canadian dollars
> **Explanation:** If the foreign currency appreciates compared to the Canadian dollar, the dividend received in that foreign currency will be worth more in Canadian dollars.
## In the given example, what is the annual dividend rate for PQR's Non-cumulative Class B Series 10 shares?
- [ ] 4.95%
- [ ] 4.85%
- [ ] 6.95%
- [x] 5.95%
> **Explanation:** In the example provided, PQR issues 5.95% Non-cumulative Class B Series 10 shares that pay an annual dividend of US$1.4875.
## How does an increase in the value of the Canadian dollar affect the dividend of foreign-pay preferred shares?
- [ ] The dividend remains constant
- [ ] The dividend will increase
- [ ] The dividend is unaffected by exchange rates
- [x] The dividend will decrease in value when converted to Canadian funds
> **Explanation:** If the Canadian dollar increases in value relative to the foreign currency, the value of the dividend in Canadian dollars will decrease when it is converted.
## What advantage do foreign-pay preferred shares have concerning taxes?
- [x] They are eligible for the dividend tax credit
- [ ] They are exempt from capital gains tax
- [ ] They involve lower tax rates on dividends
- [ ] They provide foreign tax relief
> **Explanation:** Although the dividend from foreign-pay preferred shares is received in a foreign currency, it is still eligible for the Canadian dividend tax credit because it is paid by a Canadian company.
## Which investor is most likely to benefit from owning foreign-pay preferred shares?
- [ ] An investor seeking stability in Canadian dollar income
- [x] An investor looking to earn dividends in a foreign currency
- [ ] An investor only interested in capital gains
- [ ] An investor looking for securities with no currency risk
> **Explanation:** Investors seeking to receive dividends in a foreign currency, potentially diversifying their income stream, would benefit most from foreign-pay preferred shares.
## Which of the following is NOT a potential disadvantage of foreign-pay preferred shares?
- [ ] Foreign currency risk
- [ ] The need to manage exchange rate fluctuations
- [ ] Possible lower dividend value when converted to Canadian funds
- [x] Ineligibility for the dividend tax credit
> **Explanation:** Although foreign-pay preferred shares come with foreign currency risk and the need to manage exchange rates, they are still eligible for the dividend tax credit.
## If an investor expects the Canadian dollar to depreciate against a foreign currency, what is a possible advantage of foreign-pay preferred shares?
- [x] Increased value of received dividends
- [ ] Reduced dividend payments
- [ ] Decreased foreign currency risk
- [ ] More predictable investment returns
> **Explanation:** If the Canadian dollar depreciates relative to the foreign currency, the value of dividends received in the foreign currency will increase in Canadian dollar terms.
## In the given example, if the US dollar depreciates relative to the Canadian dollar, what happens to the value of the annual dividend in Canadian funds?
- [ ] The annual dividend in Canadian funds remains the same
- [ ] The annual dividend in Canadian funds increases
- [ ] The annual dividend in Canadian funds is unaffected
- [x] The annual dividend in Canadian funds decreases
> **Explanation:** If the US dollar depreciates relative to the Canadian dollar, the value of the US$1.4875 annual dividend will decrease when converted to Canadian dollars.