Question

X-Tech Company issued preferred stock many years ago. It carries a fixed dividend of $6 per share. With the passage of time, yields have soared from the original 8 percent to 13 percent (yield is the same as required rate of return).

a. What was the original issue price? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
  
b. What is the current value of this preferred stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
  
c. If the yield on the Standard & Poor’s Preferred Stock Index declines, how will the price of the preferred stock be affected?

	The price of preferred stock will increase.
	The price of preferred stock will decrease.

Answer 1

a.

Original issue price = Fixed dividend / Original yield

Original issue price = $6 /8%

Original issue price = $75.00

b.

Current value = Fixed dividend / Current yield

Current value = $6 / 13% = 46.1538

Current value = $46.15

c.

Correct option is > The price of preferred stock will increase.

The price of preferred stock will increase because the interest rate is negatively related to price of the preferred stock. Just see part a. where we have preferred stock yield as 8% vs part b. we have yield of 13% the price of preferred stock falls in part b. which substantiate our claim of negative relationship of interest rate and price.