Question

As the required rate of return on a firm's preferred stock increases (all else equal), the price of the preferred stock will be expected to:

Select one: a. Decrease b. Increase c. Cannot be determined from above information

Answer 1

Formula for calculating the preferred stock is :

Preferred stock = Dividend/Required rate

In the question it is given that required rate is increasing and keeping all other constant.

Here, denominator is increasing which means price will decrease.

For example consider required rate of 5% and 7% with constant dividend of $3.

Preferred stock = $3/5% =$3/7%

= $60 =$42.86

Here, we can see the price of the preferred stock is decreasing with required rate increase.