CFA Practice Question

There are 191 practice questions for this study session.

CFA Practice Question

The preferred stock of the Wordsworth Institute pays a constant annual dividend of $3.00 and sells for $20.00. You believe the stock will sell for $12.00 in one year. You must, therefore, believe that the required return on the stock will be which of the following percentage points (lower/higher) in one year?

A. It will be 8.0% lower.
B. It will be 8.0% higher.
C. It will be 10.0% higher.
Correct Answer: C

User Contributed Comments 14

User Comment
cgeek how to get this answer? why $20 for this year and $12 in one year
jamiejamie first, solve for k at time t0 = 15% then, solve for k at time t1 = 25% you get these values using the preferred stock value (preferred stock value = dividend/k) then, you know that there is an INCREASE of 10% (25%-15%) Intuitively, you know that if you get the same dividend for a cheaper security price, then your K must have risen.
stefdunk the 10% increase is not in the value of the stock, but in the rate of return you expect. You want a higher payout, so the value of the share will drop (preferred stocks and bonds: value drops if payout % rises)
katybo D/K = 3/0.25 = 12 -> 0.25-0.15 = 10%
haarlemmer Sine the dividend is constant, the answer is then (3/12)-(3/20)=10%
Done think about it like it was a bond. since the price went down the yield should go up. That eliminates A and D, then do the math
faya If 3/k=20 => k=15%; If 3/k=12 => k=25%. Therefore, to get 3/k=12, you need to increase k by 10%
cfahanoi k increase => P reduce
3/12 - 3/20 = 10%
accounting go for cfahanoi
VenkatB jamiejamie - thanks for the explanation.
jansen1979 t0: $ 20 = $ 3/x => x = 15%
t1: $ 12 = $ 3/x => x = 25%

Increase of 10%
bundy 3/12 = 25
3/20 = 15 therefore 10% higher
loisliu88 cost of preferred stock=D/r, r0= D/P0, r1= D/p1
2014 Good work bundy
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