CFA Practice Question

There are 151 practice questions for this study session.

CFA Practice Question

Which of the following is (are) true about dividend policies?

I. Under the Bird-in-the-hand theory, stocks with lower pay-out ratios have higher required rates of return.
II. Under the Tax Preference theory, stocks with lower pay-out ratios have lower required rates of return.
III. Under the Modigliani-Miller theory, the price of a stock does not change with a change in the dividend policy.
A. I and III
B. I and II
C. I, II and III
Explanation: (II) is not necessarily true when the capital gains tax is higher than realized income tax.

User Contributed Comments 8

User Comment
kuan should be I II and III because capital gains tax not charged till investment gain is realised. The answer seems to play with assumptions which I feel is an exception rather than the norm
dimos The rule is that capital gains are taxed at a lower rate than dividend income. So, under the TPT, stocks with higher (lower) pay-out ratios must have higher (lower) required rates of return..From my point of view the explanation is not very clear.
mark98007 Capital Gains tax never has to be paid as long as the investor doesn't "cash in"... One could take a loan against the security to use the funds without the tax hit; a dividend always gives a tax consequence; Thus "D" IS the correct answer here as the questions is stated.
steved333 Um, cap gains is NOT lower than dividends in the US right now, and hasn't been for several years now. (and won't be if we can keep the Hildabeast out of office) Cap gains for 1 year or < is your marginal tax bracket. >1 year, as well as dividends, are a flat 15%. Therefore, II is only true if you are in the very bottom tax bracket (i.e. you don't pay any federal income tax, like 50% of this friggin' socialist-lite country thanks to the Democraps) or if you plan on holding the investment for 366 days +.
steved333 Sorry about the rant; it threw off my last sentence. I meant that II is false in that case. You want higher returns if you are paying long term gains tax or no tax on those returns. II is true if you have to suffer short term cap gains tax.
MFApassed Modigliani-Miller theory-
Any payout OK

Bird in the hand-
Set high payout

Tax preference-
Set low payout
MFApassed Retained earnings lead to capital gains, which are taxed at lower rates than dividends: 28% maximum vs. up to 39.6%. Capital gains taxes are also deferred. This could cause investors to prefer firms with low payouts, i.e., a high payout results in a low P0.
somk steved333, you sound like one of the 1%. what are you doing here with the 99%? dude, CFA is not a fan of trickle down REAGANomics.
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