Preferred Stock - CFA Level 1 Exam: Test Prep

Preferred Stock

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Preferred stock is -

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A. like a perpetuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually each quarter, for an infinite period. Because of tax advantages, the yields on preferred stocks tend to be lower than those on bonds.

B. like an annuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually once a year, for a long but finite period of time (usually 100 years). Because the dividend payments on preferred stocks are not as certain as coupon payments on bonds, preferred stocks tend to have higher required rates of return than most bonds.

C. like an annuity. The holder receives a promise from the issuer to pay a stated dividend, usually semiannually, for an infinite period of time. Because the dividend payments on preferred stocks are not as certain as coupon payments on bonds, preferred stocks tend to have higher required rates of return than most bonds.

D. like a perpetuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually semiannually, for a long but finite period of time (usually 100 years). Because of tax advantages, the yields on preferred stocks tend to be lower than those on bonds.

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A. B. C. D.

Payments of dividends for preferred stocks are only made after the firm meets its bond interest payments. One would expect the required rates of return on preferred stocks to be higher than those onbonds for this reason, but because of tax advantages, the preferred stock yields are actually lower than those on even the highest-grade corporate bonds. 80% of intercompany preferred dividends are tax-exempt, thereby increasing demand for preferred stocks and decreasing yields.

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