CFA Practice Question

There are 151 practice questions for this study session.

CFA Practice Question

Assume that all the assumptions of Modigliani and Miller hold. In particular, there are no taxes and transaction costs. A firm has a policy of paying out 5% of the stock price as dividends. However, an investor would like to receive a 7% dividend. For this, he should:
A. liquidate 2% of his stock holding after receiving the dividend.
B. use the dividend to buy 2% of the stock after receiving the dividend.
C. none of these answers.
Explanation: Suppose the investor is holding stocks worth $100. The company then pays $5 as dividends. When the dividend is paid out, the stock price falls to $95 (in the absence of tax effects, as assumed). To increase his income to $7, the investor must sell off stocks worth $2. This corresponds to 2/95 = 2.105% of the post dividend stock holding.

User Contributed Comments 8

User Comment
shasha tricky
sireklove I agree, very tricky. I wasn't aware that there was a definite one-to-one relationship between the ex-dividend change in stock price and the dividend. Also, whatever the stock price drop, it seems that the price will fluctuate soon thereafter, theoretically edging back toward it's previous level. Therefore, there would be a limited window of opportunity to cleaning calculate the exact proportion to sell. No?
Sator Should be C, IMHO
Actually is 2.105% I got to sell off, and question didn't ask for the closer answer (logically this would make C certainly incorrect), but for an exact one
jayjunk This is tricky, sometimes they accept A as a close enough approximation.
mc01 i also thought a was the answer.
good question
jackwez I wouldn't consider that a dividend.. but fair enough, a question to remember
merrick bs question that 2.105 is not a div its a stock sale. only the company can change the div. if the question asked for proceeds it would be correct. IMO
Jaminiosil initially i'd call trick question but looking into the EoC questions they do have a focus on the ex-div price so i'm glad this question punished the lazy answer
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