Stocks A and B have the same price and are in equilibrium,but Stock A has the higher required rate of return.Which of the following statements is CORRECT?
A)If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.
B)Stock B must have a higher dividend yield than Stock A.
C)Stock A must have a higher dividend yield than Stock B.
D)If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's.
E)Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.

Question

Quizplus · Accepted Answer

The required rate of return is composed of the dividend yield (expected dividend per share divided by the stock price) and the capital gains yield (expected change in price over the year). Since Stock A has a higher required rate of return, it must have a higher expected capital gains yield than Stock B. Therefore, if Stock A has a lower dividend yield than Stock B (which it must, since they have the same price but Stock A has a higher required return), then its expected capital gains yield must be higher to compensate for the lower dividend yield.

Stocks a and B Have the Same Price and Are