### CFA Practice Question

There are 191 practice questions for this study session.

### CFA Practice Question

XYZ Corp. recently issued some preferred shares with a fixed preferred rate of \$1.32 per share. Further research reveals that XYZ's common shares have a beta of 1.3 at a time when the market risk premium is 5.2% above the risk-free rate of 3.2%. If the difference in the risk premium between XYZ's common and preferred shares is 2%, what would be a fair value for the preferred shares?
A. \$15.71
B. \$16.58
C. It cannot be determined with the given information.
Explanation: Step 1. Compute the cost of common equity. R = 3.2 + 1.3 x 5.2 = 9.96

Step 2. The risk premium for preferred shares is always lower than the common equity of the same issuer. Rpre = 9.96 - 2.0% = 7.96%

Step 3. Compute value. P = 1.32/0.0796 = \$16.58

User Comment
mcspaddj The say the MRP is 5.2% above the Rf rate of 3.2%. This means the MRP is really 8.4% and the answer should be \$10.89.

It really irks me when questions aren't asked properly.
eb2568 Agreed mcspaddj, had I not missed that error I probably would have gotten the question wrong too. It is very poorly worded!
Kuki it says market risk premium is 5.2% which means Rm - Rf = 5.2%
They have given Rf as 3.2%
Therefore Return on Equity R(E) is Rf + B(Rm-Rf) = 9.96%
i dont see anything wrong here...

Note: Risk Premium will ALWAYS be above Risk free rate. Thats y its called premium....
AusPhD Yep, Kuki is correct. Sorry guys, it wasn't Analystnotes fault!