Hi ! I am having issues understanding this concept from the practice questions. Could someone help break down the correct answer? GT33G-2RQKB Thank you !
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Hi @Erika!
Thanks for sending the ID code for this question; it’s really helpful for us to look it up. And if you click on the code, it will actually copy a shareable URL for the question so you can refer back to it.
The gist is that rates have an inverse relationship with pricing. That is, when rates rise, the price of existing fixed-income securities will fall. The opposite is also true: when rates fall, the price of existing fixed-income securities will rise.
In the question, the existing preferred stock has a par value of $100 and a dividend rate of 7.70%, i.e. it cost $100 and pays the investor who owns it 7.70% annually. In a year, the dividend rate of new issues of that same stock falls to 6.90%. It still costs $100, but it pays nearly a full percentage point less. The stock paying 7.70% is more attractive to investors than the same stock paying 6.90%. And as such, it is effectively more valuable, so its market price will rise above the original price of $100.
We cover this topic more thoroughly in our SIE chapter on How interest rates affect preferred stock.
Please let me know if this helps or if we can break it down further!
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Thank you so much for the clarification !
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