Please some help !
Data are given regarding a preferred stock:
Par value $80 Dividend rate 8% Yield on comparable preferred stock 10.5% Price $60 How can we know if this stock is overvalued/undervalued or well priced? Don’t get how a preferred stock like this one works (equity? fixed income?) Thanks!
Think of preferred stock as a perpetuity: it pays a fixed dividend forever, so you can calculate the fair price from the dividend amount and the required return, using the perpetuity formula:
P0 = D / r
Here, D = $80 × 8% = $6.40, so,
P0 = $6.40 / 10.5% = $60.95.
At $60/share, it’s underpriced by 95¢/share.
Thnaks very much, very helpful!
You’re welcome.
Good to hear.
What is meant by “yield on a comparable stock”? Does it mean dividend yield or the market yield? If yes, why are we dividing the dividend offered on the first stock by the yield on the second stock?
Wait . . . you’re asking “Is it A or is it B?” and your answer is “Yes.”? Weird.
Because preferred stock is, in essence, an annuity, the market yield (total return?) and the dividend yield should be the same: dividends are the only source of return (assuming a stable required return).
[quote=“S2000magician”]
Lol. I need some sleep. I just pooped in there. How did I even write that? Bad scores getting getting under my skin 
I have seen cases where dividend yield and mkt yield are diffr. E.g. A 5.8% preferred stock with a par value of 1000 has an annual yield of 5.4%. Look, 5.8 ain’t equal to 5.4 What am I missing?
When they refer to the stock as 5.8% preferred, that simply means that the annual dividend is 5.8% of the par value (or $58.00 in your $1,000 par example). When they say that the annual yield is 5.4%, that means that at the market price of the preferred stock, the annual yield ($58.00 ÷ market price) is 5.4%; obviously, the market price of the stock is $1,074.07 (= $58.00 ÷ 5.4%).
So, annual yield is diffr or same as divided yield?
They should be the same: dividends are the only thing you get. (Again, assuming that the required rate of return remains unchanged. If that changes, there will be a price change, of course. That will not happen on the Level I CFA exam.)