Question

Why is a change in required yield for preferred stock likely to have a greater impact on price than a change in required yield for bonds?

Short answer

Change in required yield has a greater impact on Preferred stock than on bonds due to the indefinite time element in the case of preferred stock.

Step-by-step solution

Preferred Stock

Preferred stock provides a fixed payment of dividends having a higher order of precedence than common stock but does not provide ownership privilege. Due to its fixed payment over an indefinite period, it is also called a perpetuity.

Impact of change in yield for preferred stock vs. change in the yield for bonds

As stated, preferred stock is a kind of perpetuity, and perpetuity is valued by just dividing the dividend payment by the required yield.

The formula for this would be –

$\mathbf{Price}\mathbf{}\mathbf{of}\mathbf{}\mathbf{prefferd}\mathbf{}\mathbf{stock}\mathbf{\left(}{\mathbf{P}}_{\mathbf{p}}\mathbf{\right)}\mathbf{=}\frac{\mathbf{Dividend}\mathbf{}\mathbf{payment}\mathbf{\left(}{\mathbf{D}}_{\mathbf{p}}\mathbf{\right)}}{\mathbf{Required}\mathbf{}\mathbf{yield}\mathbf{\left(}{\mathbf{K}}_{\mathbf{p}}\mathbf{\right)}}$

On the other hand, the bond is valued by taking the present value of every interest payment at different points in time and valuing the present value of the principal amount at the maturity date.

So due to the indefinite time factor in the case of preferred stock, the impact on price would be higher than the valuation of bond.