Question

Barnes Air Conditioning Inc. has two classes of preferred stock: floating rate preferred stock and straight (normal) preferred stock. Both issues have a par value of $100. The floating rate preferred stock pays an annual dividend yield of 4 percent, and the straight preferred stock pays 5 percent. Since the issuance of the two securities, interest rates have gone up by 2.50 percent for each issue. Both securities will pay their year-end dividend today.

What is the price of the straight preferred stock likely to be? (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

Answer 1

Par value = $100

At time of issue.

Dividend rate of floating rate preferred stock = 4%

Dividend yield on straight preferred stock = 5%

Current Time

a.

Interest rates have gone up by 2.50 percent for each issue.

So, Dividend rate of floating rate preferred stock bond also increase by 2.50%. CO citent Dividend rate of floating rate preferred stock is 6.50% and for Dividend yield on straight preferred stock remains same that is 5%.

Year year dividend on floating rate preferred stock = $100 × 6.50%

= $6.50.

Year year dividend on floating rate preferred stock is $6.50.

Year year dividend on straight rate preferred stock = $100 × 5%

= $5.00

Year year dividend on straight rate preferred stock is $5.00.

b.

Price of Straight Preferred stock = Annual Dividend / Current market interest rate

= $5 / 6.50%

= $76.92.

Price of Straight Preferred stock is $76.92.