[\]^@A Guide to PreferredStock and RelatedSecurities

“Is it a stock or is it abond?” The answer isneither. Preferred stocksare “hybrid” securities

that combine some of the most attractive featuresof both fixed income bonds and equity securities.While both individual and institutional investorshave participated in the preferred stock market,the introduction of other forms of preferred stockand preferred stock-like securities in 1993prompted an increasing number of individualinvestors to become active in this market. Thisbrochure has been created to familiarize potentialinvestors with the intricacies of preferred stocksand other related securities, referred to as $25debt securities.

Preferred stock can be an important part of adiversified portfolio; however, investors areencouraged to thoroughly understand the charac-teristics of these securities as well as the factorswhich may impact their value.

Note: Because of the complexity of certain relatedtax issues with regard to the securities describedherein, investors should consider their particularcircumstances and consult with their tax advisorto determine if an investment in these securitiesis appropriate. Current or future proposed legislationcould alter the tax treatment of certain preferredsecurities that are described in this brochure.

Some of the more conventional types ofpreferred stock includefixed-rate, adjustable-

rate, and convertible issues.* However, the preferred stock market continues to expand asnew structures are developed. Some of thesestructures include Monthly Income PreferredSecurities (MIPSSM), Quarterly Income Preferred

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INTRODUCTIONTO PREFERREDSTOCK

TYPES OFPREFERREDSTOCK

* Convertible preferred stocks are not discussed in this brochure.

Securities (QUIPSSM) and Trust OriginatedPreferred Securities (TOPrSSM), to name a few.*

1. Fixed rate preferred stock—These securi-ties carry a fixed dividend rate which is usual-ly stated in dollar terms or as a percentage ofthe preferred’s par value. This characteristicis similar to that of a bond because a set dol-lar amount will be received by the investor onthe preferred stock’s payment date (usuallyquarterly). These securities differ from bonds,however, in that they have no maturity date.

2. Adjustable rate preferred stock—Adjustable rate preferred stocks have divi-dend rates which are periodically reset basedon a benchmark. These benchmark ratesinclude the annual market discount rate forthree-month Treasury bills, the 10-yearConstant Maturity Treasury note rate, LIBOR(which stands for London Interbank OfferingRate), or some combination thereof. Generally,the dividends will be subject to minimum andmaximum rate levels over an issue’s life.

3. Monthly Income Preferred Securities(MIPSSM)—These securities, first introducedin 1993, are typically issued through specialpurpose entities which may be structured as aLimited Life Corporation (LLC), LimitedPartnership (LP), or business trust. The pro-ceeds raised from the sale of the preferredshares are loaned to the corporate parent ofthe special purpose entity. This loan can alsobe made through the purchase of a subordinat-ed debt security originated by the parent. Theparent corporation is obligated to pay interestto the special purpose entity, either from inter-est payments made on the subordinated bondor from interest paid on the loan. These pay-ments, usually made on a monthly basis, are in

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* MIPS and QUIPS are registered servicemarks of GoldmanSachs; TOPrS is a registered servicemark of Merrill Lynch.

turn passed to the MIPSSM holders in the formof dividends. Interest payments on the loan, orsubordinated debenture, may be deferred fortypically up to 60 consecutive months. If thisoccurs, distributions on the preferred securi-ties will be deferred for the same period.Because of the issuer’s right to defer the pay-ment of interest, the securities are treated fortax purposes as though they were issued withoriginal issue discount (OID). Holders of thepreferred securities are required to include the amount of the income that accrues in anymonth as taxable income for income tax pur-poses, regardless of whether any distributionsare received. (See the “Special Risks” sectionon page 10 for further details.)

In cases where a subordinated debenture isthe basis for the loan, there may be certainevents that occur which could cause a liquida-tion of the preferred securities and subse-quent distribution of the subordinated deben-tures to holders of the preferred securities.Most features of the subordinated debenturesmatch those of the preferred securities.

While earlier MIPSSM issues have mandatoryredemptions of as long as 100 years, morerecent securities have mandatory redemptionsof 50 years or less. Redemptions will coincidewith the term date of the underlying loan orsubordinated debenture. Where LLC or LPstructures are used to issue securities, holdersare considered partners for federal tax purpos-es and the accrued income is reported on aForm K-1, in lieu of reporting on Form 1099.

Keep in mind that distributions made on thepreferred securities will depend on the parentcorporation’s ability to pay interest on the sub-ordinated debt security. Therefore, an invest-ment decision on the preferred security is alsoan investment decision on the subordinateddebt security.

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4. Quarterly Income Preferred Securities(QUIPSSM)—The issuing entity of QUIPSSM isstructured as a special purpose entity in thesame fashion as MIPSSM. The major differencebetween MIPSSM and QUIPSSM is the frequencyof the dividend payment, with the latter payingdividends on a quarterly basis. Except for thedividend frequency, features of QUIPSSM are virtually identical to MIPSSM. (See precedingMIPSSM section on page 3 for further details.)

There are also some QUIPSSM that have beenissued by companies organized as GrantorTrusts. These QUIPSSM share the same charac-teristics as Trust Originated PreferredSecurities, which are explained below.

5. Trust Originated Preferred Securities(TOPrSSM)—Companies that issue TOPrSSM

are organized as business trusts eligible forGrantor Trust treatment under the InternalRevenue Code (IRC), meaning that for federalincome tax purposes, the issuing entity is notclassified as an association taxable as a corpo-ration or partnership; rather, each TOPrSSM

holder will be considered an owner of anundivided interest in a subordinated debtsecurity. As such, income on the preferredsecurities is reported to holders on an accrualbasis on IRS Form 1099-OID.

Like some MIPSSM and QUIPSSM, when a newTOPrSSM is issued, the proceeds from the saleare used to purchase a long-term, subordinat-ed debenture issued by the trust’s parentcompany, the proceeds from which are loanedto the parent company. Interest payments onthe subordinated bond are paid to the issuingtrust which, in turn, uses these funds to paydistributions to the preferred securities hold-ers. These payments are typically made on a quarterly basis.

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Similar to MIPSSM and QUIPSSM, TOPrSSM alsohave mandatory redemption dates that corre-spond to the maturity of the subordinateddebenture. Some issuers of TOPrSSM may alsohave the option to extend the maturity of thesubordinated debentures for a specified peri-od of time (e.g., up to an additional 19 years).If this occurs, the mandatory redemption ofthe preferred security is extended by thesame number of years.

Just as with MIPSSM and QUIPSSM securities,issuers of TOPrSSM may, under the indenture,defer payments of interest on the subordinat-ed debt security for a specified period of time(e.g., 20 consecutive quarters). Should thisoccur, distributions on the preferred securi-ties will be deferred for the same period.Thus, holders of the TOPrSSM are required toinclude the amount of income accrued in anyquarter as taxable income for U.S. federalincome tax purposes, regardless of whetherany distributions are received. The accruedincome will be reported annually on IRS Form 1099-OID. (For further details, see the“Special Risks” section on page 10.) Therealso may be certain events which could causea liquidation of the TOPrSSM and a subsequentdistribution of the subordinated debenturesto the holders of the TOPrSSM. The subordinateddebentures would have features similar tothose of the TOPrSSM.

Distributions on the TOPrSSM are dependenton the subordinated debt issuer’s ability topay interest on such debt. Therefore, aninvestment decision on the preferred securityis also a decision with regard to the subordi-nated debt security.

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The following are a fewof the most common fea-tures of preferred stock:

■ Ranking of Preferred Stock—Preferredstock is senior to common stock in terms ofcapital structure, but junior to all other unse-cured indebtedness of the issuer, including allexisting and future liabilities of the company.

■ Cumulative dividends—Unlike equity securi-ties, the dividends of most preferred stocksare cumulative. This means unpaid dividendsaccumulate, and, if in arrears, must be paidby the issuer prior to fulfilling obligations toholders of common stock.

■ Intercorporate dividend exclusion—Somepreferred stocks qualify for the 70% intercor-porate dividend received deduction (DRD).This means that eligible U.S. corporations areable to exclude 70% of preferred stock divi-dends from gross income. This exclusion doesnot apply to S corporations (Refer to Sections243 and 246 of the Internal Revenue Code foreligibility). The DRD can be altered by futuretax law changes. Furthermore, MIPSSM,QUIPSSM, and TOPrSSM do not qualify for the70% DRD.

■ Maturity structure—Most conventional preferred stock issues do not have a maturitydate; however, many MIPSSM, QUIPSSM, andTOPrSSM have mandatory redemption dates.For details, see the previous section relatingto the types of preferred stock.

■ Redemption provisions—Most preferredstock issuers retain the right to retire securi-ties through redemption provisions. Althoughthe terms differ for each issue, a number ofpreferred stocks are redeemable after five to10 years, in whole or in part, at either par or a

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FEATURES OFPREFERREDSTOCK

premium to the original par amount. The pre-mium, if any, usually declines to par over a specified period of time.

■ Preference of assets—In case the issuingcorporation, or special purpose entity, experi-ences financial failure, preferreds usually contain provisions that entitle shareholders to the liquidation preference of the preferredsecurity before distributions to commonstockholders can be made. This provision isactivated once settlements with creditors andsenior debt holders are met. Keep in mindthat, as previously mentioned, preferred stockis subordinate to all secured and unsecuredcreditors of the issuing entity.

■ Preference of dividends—Preferred stockdividend payments are considered senior tothe common stock dividend payments. Forinstance, if an issue is cumulative, the issuercannot pay any dividends to common stock-holders before obligations to the preferredholders have been met.

■ MIPSSM, QUIPSSM, and TOPrSSM are exemptfrom Non-Resident Alien (NRA) with-holding—Dividends on U.S. preferred stocksare generally subject to 30% (or lower treatyrate) withholding for NRA holders. However,distributions on MIPSSM, QUIPSSM, and TOPrSSM

are exempt from U.S. withholding when anNRA has provided a W-8.

Like most other types of investment vehicles,preferred stockshave certain risks ofwhich the investorshould be aware.*

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* This risk summary is not intended to be complete. Other risks relating to a specific issue may exist and are disclosed in the security’s prospectus.

RISKS RELATINGTO PREFERREDSTOCK

■ Call provisions—When evaluating the pur-chase of a preferred stock, one should be aware of any features that may allow theissuer to call the security. This is particularlyimportant when considering an issue that istrading at a premium to its call price because,if the issue is redeemed, the return may benegatively impacted.

■ Sinking funds—Should a preferred stock besubject to a sinking fund, the issuer is typical-ly required to retire a certain percentage ofthe total issue over a specified period of time.Eventually, much of the preferred stock issuecould be retired in this manner. The primarydifference between a call provision and asinking fund is that the issuer calls securitieson a voluntary basis whereas a sinking fund isusually mandatory and must conform to a setschedule. Just as with call provisions, oneshould be aware of the potential impact to apreferred stock’s return if it is subject to asinking fund provision. MIPSSM, QUIPSSM, andTOPrSSM are not usually subject to sinkingfund provisions.

■ Limited voting rights—Generally, preferredstock shareholders do not have voting rightsunless preferred dividends have been in arrearsfor a specified number of periods. At that point,investors may elect some number of directorsto the issuer’s board. Once all the arrearageshave been paid, however, the preferred stock-holders no longer have voting rights.

In the case of MIPSSM, QUIPSSM and TOPrSSM,shareholders have no voting rights, except 1)if the issuer fails to pay dividends for a speci-fied period of time (usually a period that is

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longer than the allowed dividend extension),or 2) if a declaration of default occurs and iscontinuing. In the case of such an event, rights of holders would generally include theright to appoint and authorize a trustee toenforce the company’s rights as a creditorunder the agreement with the parent.

■ Special redemptions—There exist certainconditions under which a preferred issuer canredeem shares prior to a specified date. Whilethese circumstances can vary from issue toissue, investors should be aware of the eventsthat can trigger such a redemption. Forinstance, in the case of MIPSSM, QUIPSSM andTOPrSSM, the securities may be redeemedshould a change occur to federal income taxlaw or federal securities laws pertaining tothese securities. Occurrences that may triggerspecial redemptions can be located in anissue’s prospectus.

■ Liquidity—Most preferred securities are list-ed on a major stock exchange (e.g., the NewYork Stock Exchange), providing investorswith a degree of liquidity. While PaineWebberendeavors to make a market for preferredsecurities, it is under no obligation to do so.Accordingly, no assurance can be given as tothe liquidity of, or trading markets for, pre-ferred securities.

■ Interest rate fluctuation—Because pre-ferred stocks are interest rate sensitive, theprevailing rate environment can cause themarket level of an issue to fluctuate. Forexample, if interest rates are rising, preferredstock issues could experience a decline inmarket value.

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■ Credit risk—The creditworthiness of anissuer will influence both the ability to makedividend payments as well as the level atwhich shares will trade. Even if the issuer ispaying dividends, but is downgraded, the mar-ket value may be adversely affected. Forinstance, if the rating of an issuing corpora-tion’s preferred stock is downgraded, or onwatch for a potential downgrade, the sharescan depreciate in price.

With regard to the afore-mentioned securities, inmost cases, the parentcompany may defer pay-ment of interest on thesubordinated debenture,

or the loan as the case may be, for a specifiedperiod of time (typically up to 60 consecutivemonths or 20 consecutive quarters). If this occurs,dividend payments on the preferred securities willbe deferred for the same time frame and the mar-ket value of the security is likely to be affected.

For U.S. federal income tax purposes, should anextended payment period occur, holders would be required to include the accrued income inadvance of the receipt of cash. Should a holderdispose of shares prior to the record date for pay-ment of dividends following such an extendedperiod, they would not receive the cash related to the accrued, yet unpaid, income. (A holder’s taxbasis would be increased for accrued income notyet received.) Typically, the parent company maynot pay dividends on, redeem, purchase, oracquire any of its capital stock should such adeferral occur.

In addition, should the issuer exercise its right todefer payments on the preferred securities, themarket price and liquidity on the securities wouldlikely be adversely affected.

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SPECIAL RISKSRELATINGTO MIPSSM, QUIPSSM, AND TOPRSSM

Corporations can issuedifferent classes of pre-ferred stock but aresometimes limited to theamount of senior pre-ferred shares they are

allowed to have outstanding. As a result, issuersmay offer different preferred stock classes thatare not subject to the same limitations.

■ Senior preferred shares—These shares haveclaim to assets before preference, or junior,shares should the issuing corporation beforced to liquidate. Senior preferred sharesalso have first claim to dividends and cansometimes receive payments when a juniorclass does not.

■ Junior preferred shares, or preferenceshares—Generally, preference shares rankbelow senior preferred shares, but above com-mon stocks. There can be several series ofpreference shares, each ranking equally withthe other in terms of claims to dividends andassets. Other rights or restrictions can exist,usually on an issue by issue basis.

■ Depositary preferred shares—Depositaryshares represent a fractional interest in awhole share of preferred stock or preferenceshare. The underlying preferred is depositedwith a custodian and is never traded in thesecondary market. Fractions of the underlyingpreferred stock can then be created. Theresulting depositary, or fractional, shares enti-tle the holder to proportionally the same priv-ileges as the underlying preferred stock.

In general terms, MIPSSM, QUIPSSM, andTOPrSSM usually rank equally with (paripassu) the senior most preferred stock of theparent company. However, there are someexceptions. Individual priority rankings arespecified in an issue’s prospectus.

WHAT ARETHE DIFFERENTCLASSES OFPREFERREDSTOCK?

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Originally, many pre-ferred stock buyers werelarge institutions whichpurchased preferred

stocks to take advantage of their special tax treatment. However, with the advent of the newpreferred stock structures not eligible for theintercorporate dividend received deduction, indi-vidual investors now comprise a large portion ofthe preferred market volume. Consider the follow-ing advantages:

■ Preferred stock offers attractive returns—Because many preferred stock issues trade atyield premiums versus long-term Treasuries,investors are able to realize attractivereturns. For eligible corporations, the higherafter-tax yields, due to the 70% intercorporatedividend received deduction, make owningpreferred stocks particularly beneficial.

Furthermore, MIPSSM, QUIPSSM, and TOPrSSM

typically offer additional yield spread versusother types of preferred stocks. This differ-ence is partially attributed to the fact thatthey do not qualify for the 70% intercorporatedividend received deduction. Issuers compen-sate investors for this lack of special tax treat-ment in the form of additional yield. Since theintercorporate dividend received deductiondoes not apply to individual investors, theyield premium above Treasury securities canbe especially appealing.

■ Marketability of preferred stock—Mostpreferred stocks trade on various exchanges,including the NYSE, AMEX, or over-the-counter. There can be no assurance, however,of the development or maintenance of anactive market for the preferred securities onthe exchange.

■ Purchasing power—Investors are able topurchase preferred stocks with low paramounts of $10, $25, $50 or $100.

WHY PURCHASEPREFERREDSTOCK?

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Another example of thechanging nature of thismarket is the introduc-

tion of $25 par debt securities. While these instru-ments are technically regarded as subordinateddebt, they have characteristics that are similar tothose of MIPSSM, QUIPSSM, and TOPrSSM. Includedamong these debt securities are: Monthly IncomeDebt Securities (MIDSSM), Quarterly Income DebtSecurities (QUIDSSM), and Quarterly IncomeCapital Securities (QUICSSM).*

Some of their more common characteristicsinclude:

■ Monthly or quarterly interest payments—As their names indicate, MIDSSM pay on amonthly basis, while QUIDSSM and QUICSSM

pay on a quarterly basis.

■ Deferral of interest payments—The issuingcompany has the right to defer interest pay-ments for a certain period of time, as speci-fied in the prospectus (typically up to 60 con-secutive months or 20 consecutive quarters),possibly resulting in an adverse impact onmarket value and liquidity (see the risk sec-tion which follows).

■ Coupons are usually fixed-rate and cumulative—In most cases, these securitieshave a set interest rate. In the event thatinterest payments are deferred, such pay-ments will accumulate, and must be paid bythe issuer prior to fulfilling obligations toholders of capital stock. Additionally, someissuers are required to pay interest on theaccumulated deferred payments, althoughthis feature does not apply to all issues.

OTHER RELATEDSECURITIES

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* MIDS and QUIDS are servicemarks of Goldman Sachs;QUICS is a servicemark of Lehman Brothers.

■ Final maturity—These securities have afinal maturity, usually 30 years, with theoption to redeem the securities, typically afterfive to 10 years.

■ Not eligible for the Intercorporate DividendReceived Deduction (DRD)—Because thesesecurities are interest bearing, subordinateddebentures, they are not eligible for the 70%dividend received deduction.

■ Listing—Most of these debt securities arelisted on a major stock exchange, such as theNew York Stock Exchange. However, there canbe no assurance of the development or main-tenance of an active market for the debt secu-rities on the exchange.

■ Priority to assets—Because these securitiesare usually subordinated debt obligations ofthe issuer, their claim to the assets of theissuing corporation, in most cases, is senior tothat of preferred stock holders. However,these securities rank junior in status to allother secured or unsecured debt of the issu-ing corporation.

■ Interest reported on IRS Form 1099—Interest payments from these debt securitiesare reported on IRS Form 1099-OID.

■ Exempt from NRA Withholding—Just aswith MIPSSM, QUIPSSM, and most TOPrSSM, dis-tributions on MIDSSM, QUIDSSM, and QUICSSM

are exempt from U.S. withholding when anNRA has provided a W-8.

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Investors consideringthe purchase of thesedebt securities should be aware of their

specific risks. A few of these risks are summa-rized below:*

■ Effects of deferral feature—For income taxpurposes, the interest on these issues isincluded in the income of the investor as itaccrues, rather than when it is paid. Shouldthe issuer exercise its option to defer interestpayments for a specific time period, the hold-er of the security would still be required toreport the annual accrual of interest on thebond prior to the receipt of the cash. In addi-tion, an interest deferral may negativelyimpact the market value of the debt security.

■ Interest rate risk—Like preferred stocks,these securities are affected by changes inthe level of interest rates. For example, ifinterest rates are rising, these securitiescould experience a decline in their marketvalue.

■ Credit risk—The creditworthiness of anissuer may affect the ability to pay dividendsas well as influence the level at which shareswill trade. Erosion of a company’s credit rating can negatively impact a security’s market value.

SOME RISKSRELATING TOTHESE SECURITIES

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* Other risks may exist similar to those outlined on pages 7-10 of this brochure. These risks are disclosed inthe security’s prospectus.

PaineWebber is an activeparticipant in both theprimary and secondarymarkets for preferred

stock and related securities. Primary preferredstocks and $25 par debt securities are sold byprospectus. Shares in the secondary market tradeeither over-the-counter or on a major stockexchange, like the NYSE.

The evolution of pre-ferred stocks and relatedsecurities has placedPaineWebber among theleading underwritersand market makers forthese issues. Call your

PaineWebber Financial Advisor and ask for moreinformation about preferred stock. It could be theinvestment you need to accomplish your portfo-lio’s objectives.

WHY INVEST INPREFERREDSTOCKS ANDRELATEDSECURITIES ATPAINEWEBBER?

THE PRIMARY VS.THE SECONDARYMARKET

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