Question

1.Which of the following statements is (are) correct?(x)A stock can provide a return by paying a dividend, increasing in value or by some combination of the two.(y)A change in the ability of company to pay a dividend or a change in the required return will, in general, cause the price of a preferred share of stock to change.(z)Like bonds, the price of a preferred share varies inversely with the rate of return required by investors.

A.(x), (y) and (z)

B.(x) and (y) only

C.(x) and (z) only

D.(y) and (z) only

E.(z) only

4.You just purchased preferred shares in Citicorp(C.PRP) for $28.45. Your required return on this investment is 6.5 percent. What is amount of the annual dividendon this stock?

A.$0.55

B.$1.85

C.$1.95

D.$2.20

E.$2.85

5.Which of the following statements is (are) correct?(x)If the required rate for an investor is above 4.5% and the expected rate of return on Big Baskets stock is about 6.0%, then the stock is probably not a good buy for the investor. (y)The required return is what an investor needs to earn to be satisfied that he or she has been adequately compensated for the risk of owning the security.(z)A 5.0percent preferred stock with a market price of $90 per share and a $100 par value pays a cash dividend of $4.50.

A.(x), (y) and (z)

B.(x) and (y) only

C.(x) and (z) only

D.(y) and (z) only

E.(y) only

Answer 1

1]

A - all statements are correct

(x) - A stock's returns could be through dividend income or capital gains

(y) - price of preferred stock is determined by required return and dividend payment. If either of these change, the price will change

(z) - Required return is the discount rate used to price bonds and preferred stock. The cash flows of interest and principal are discounted to the present using the required return to price the bond/stock today. Hence, higher required returns means lower prices, and vice versa.

4]

price of preferred share = annual dividend / required return

$28.45 = annual dividend / 6.5%

annual dividend =  $28.45 * 6.5% = $1.85

The answer is B

5]

E - only (y) is correct

(x) - if the expected return is higher than the required return, it is a good buy.

(y) - Required return is the minimum compensation required by investors for the risk that they take

(Z) - cash dividend = 5% * $100 = $5