Question of the Week

You expect to sell your only stock in 2 years time at a price of $42.50, just after it pays a dividend of $1.75. (Assume no other dividends were paid during this time). This stock is currently worth $34.80. What would the minimum APR (or stated annual interest rate) have to be on a mortgage backed security so that you would rather hold the MBS as opposed to the stock?

a) 12.38%
b) 12.76%
c) 1.00%
d) 12.07%

Answer:

The correct answer is: d)

Step 1: Find the equivalent monthly return from the stock investment

FV = (42.50 + 1.75) = 44.25
n = 24
i = ? = 1.006
PV = 34.80

Step 2: Compute the APR

APR = 1.006 x 12 = 12.07

Therefore, the APR on the MBS must be at least equal to 12.07%

2006 CFA Level 1 LOS: 2.6.e


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