CFA Level I Exam · Equity Instrument Features

Types of Equity Securities for CFA Level I

Updated 7 October 2026 · Fact-checked

Equity securities represent ownership in a company. The two main types are common shares, which carry voting rights and a residual claim on income and assets, and preference shares, which usually pay a fixed dividend and rank ahead of common shares but behind debt. Solve questions by comparing claim priority, dividend features and rights.

Understand Types of Equity Securities

An equity security is a claim on the ownership of a company. Equity holders are paid after creditors. This is why equity is called a residual claim: owners receive what is left after all other claims are met.

Common shares are the most basic form of equity. Holders usually have voting rights, such as electing directors. They receive dividends only if the board declares them. There is no fixed amount and no promised date. In return, common shareholders keep the upside: if the company does well, the share price and dividends can rise without a cap. In liquidation, common shareholders are paid last.

Preference shares (preferred shares in US usage) sit between debt and common equity. They usually pay a fixed dividend, often stated as a percentage of par value. Preferred dividends are paid before any common dividend. In liquidation, preferred holders rank ahead of common holders, but behind debt holders. Preferred shares usually have no voting rights, or limited ones. Unlike interest on debt, a missed preferred dividend is not a default.

Preference shares come with features that change who bears risk:

Cumulative: unpaid dividends build up as arrears. They must be paid before any common dividend. This favours the holder, so the required dividend is lower. Non-cumulative: missed dividends are lost. This favours the issuer, so the investor wants a higher dividend.
Participating: holders receive the stated dividend plus an extra share of earnings above a set level, or an extra amount in liquidation. This favours the holder, so the required dividend is lower. Non-participating: holders receive only the stated dividend and the stated liquidation amount. This favours the issuer, so the investor wants a higher dividend.
Convertible: holder may convert into a set number of common shares. This favours the holder, so the dividend is usually lower.
Callable: the issuer may redeem the shares at a set price. This favours the issuer, so the investor wants a higher dividend.
Putable: the holder may sell the shares back to the issuer at a set price. This favours the holder.
Adjustable or floating rate: the dividend resets with a reference rate, which reduces interest rate risk.

A simple rule helps you on the exam. A feature that benefits the holder (convertible, putable, cumulative, participating) makes the share more valuable, so it tends to carry a lower dividend yield or higher price. A feature that benefits the issuer (callable, non-cumulative, non-participating) does the opposite.

Key formulas to remember

Order of claims on assets: Debt holders > Preference shareholders > Common shareholders; Common equity is the residual claim. Each class is paid in full before the next one receives anything.
Order of claims on income: Interest on debt > Preferred dividends > Common dividends; Interest is a contractual obligation. Preferred and common dividends are paid only if declared.
Annual preferred dividend: Dividend = Dividend rate × Par value; For example, a 5% preferred with par value $100 pays $5 per share per year.
Cumulative arrears: Dividend owed = Annual dividend × Number of years missed (plus the current year); Applies only to cumulative preferred. Arrears must be paid before any common dividend.
Conversion value of convertible preferred: Conversion value = Conversion ratio × Current common share price; Compare with the market price of the preferred to judge whether conversion is attractive.

How to solve Types of Equity Securities questions

Use this routine for any question on types of equity securities. It keeps you from mixing up holder-friendly and issuer-friendly features.

1Identify the security: common, preferred, or a variant such as convertible or callable.
2List the claims being compared: income (dividends) or assets (liquidation).
3Apply the priority order: debt, then preferred, then common.
4Read every feature word in the stem: cumulative, participating, callable, convertible, putable, adjustable.
5Decide who benefits from each feature: the holder or the issuer.
6If numbers are given, calculate the dividend, arrears or conversion value.
7Check each option against your findings and eliminate the two that contradict a rule.
8Confirm that your answer matches the exact wording of the stem.

Quickest way: Holder or issuer: the 20-second check

When to use it: Use it for theory questions that ask which feature, claim or risk applies, when you have about 90 seconds.

Write the order of claims: debt, preferred, common.
For each feature in the question, tag it H (holder benefits) or I (issuer benefits).
Cumulative, participating, convertible, putable = H. Callable, non-cumulative, non-participating = I.
Match the tag to the option. H features raise value and lower required yield. I features do the reverse.
Eliminate options that say preferred dividends are guaranteed or that preferred ranks below common.

Common mistakes in Types of Equity Securities

Thinking a missed preferred dividend is a default.
Preferred dividends look like fixed interest payments.
Fix: Dividends are paid only if declared. Missing one is not a default. For cumulative preferred, it creates arrears instead.
Confusing cumulative with participating.
Both sound like extra money for the holder.
Fix: Cumulative is about catching up on missed dividends. Participating is about sharing in earnings above the stated dividend.
Assuming preferred shareholders rank ahead of debt holders.
The word 'preference' suggests top priority.
Fix: Preference is only over common shares. Debt holders are always paid before preferred shareholders.
Treating callable as a holder-friendly feature.
Students assume any extra feature adds value for the investor.
Fix: A call lets the issuer redeem when rates fall. This hurts the holder, so callable preferred needs a higher yield.
Assuming all common shares carry equal voting rights.
Basic notes say common shares vote.
Fix: Some companies have share classes with different or no voting rights. Read the stem for class details.
Assuming preferred shares always have no voting rights.
It is the usual case, so it gets stretched into a rule.
Fix: Say 'usually'. Preferred holders may gain voting rights in some situations, such as missed dividends.

Worked examples

Example 1

A company has 50,000 cumulative preferred shares with par value $100 and a 6% dividend rate. It paid no preferred dividend last year and none this year so far. The board now wants to pay a common dividend this year. What total preferred dividend must be paid first? A) $300,000 B) $600,000 C) $900,000

Show the solution

Annual dividend per share = 6% × $100 = $6.
Annual dividend for all shares = 50,000 × $6 = $300,000.
Cumulative preferred means last year's missed dividend is owed as arrears: $300,000.
This year's dividend is also due before any common dividend: $300,000.
Total = $300,000 + $300,000 = $600,000.

Answer: B) $600,000. A would ignore arrears, and C would count an extra year.

Example 2

Which feature is most likely to let a preferred issuer pay a lower dividend rate than on otherwise identical preferred shares? A) A call feature B) A conversion feature C) A non-cumulative feature

Show the solution

A lower dividend rate is acceptable to investors when they receive extra value.
Tag each feature. A call feature is issuer-friendly (I), so investors demand a higher dividend.
A non-cumulative feature is also issuer-friendly (I) because missed dividends are lost, so it also pushes the required dividend higher.
A conversion feature is holder-friendly (H), since it gives the right to own common shares and share in upside.
So investors accept a lower dividend with a conversion feature.

Answer: B) A conversion feature. A and C favour the issuer, so they push the required dividend up, not down.

Exam tips

Memorise the claim order once: debt, preferred, common. Many wrong options simply swap two of them.
Questions on features usually test who benefits. Tag each feature as holder-friendly or issuer-friendly before reading the options.
Watch for absolute words such as 'always' or 'guaranteed' about preferred dividends. They are usually wrong.
With no penalty for wrong answers, never leave a question blank. Eliminate options that break the priority order, then pick from what remains.
In arrears questions, count every missed year plus the current year, and multiply by the full annual dividend.

Practice questions from Equity Instrument Features

Types of Equity Securities in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

NISM CertificationsTypes of Securities and Market Instruments

Types of Equity Securities: frequently asked questions

What is the difference between common and preference shares?

Common shares carry voting rights and a residual claim, with dividends that vary and are paid last. Preference shares usually pay a fixed dividend, rank ahead of common in dividends and liquidation, and often have no voting rights. Both rank behind debt.

What is the difference between cumulative and participating preferred shares?

Cumulative preferred accumulates unpaid dividends as arrears that must be paid before any common dividend. Participating preferred pays the stated dividend and also lets holders share in extra earnings or liquidation proceeds. One protects missed income, the other adds upside.

What is the difference between callable and convertible preference shares?

Callable preferred gives the issuer the right to redeem the shares at a set price, which benefits the issuer. Convertible preferred gives the holder the right to exchange them for common shares, which benefits the holder. Callable shares need a higher dividend, and convertible shares usually pay a lower one.

Are preferred shares debt or equity?

They are equity, though they have debt-like features such as a fixed dividend and priority over common shares. They rank behind debt, and missing a dividend is not a default. On the exam, treat them as a hybrid sitting between debt and common equity.