Certified Financial Management Specialist Practice Exam

Which dividend policy allows investors to experience full volatility of company earnings?

1. Stable Dividend Policy

2. Constant Dividend Policy

3. No Dividend Policy

4. Residual Dividend Policy

The correct answer is: Constant Dividend Policy

The constant dividend policy allows a company to maintain a fixed dividend payout to shareholders, regardless of its earnings performance. This results in investors experiencing less volatility in the cash flows they receive compared to the fluctuations in the company's earnings. In contrast, a stable dividend policy aims to provide shareholders with predictable dividends, even if it means that the company might not distribute all available earnings. This stability mitigates the impact of earnings volatility on dividends. The residual dividend policy ties dividends to actual earnings and investment opportunities, meaning that if a company's earnings are high, it could pay out larger dividends, while lower earnings might lead to little to no dividend at all, allowing investors to fully experience the fluctuations of the company's earnings. No dividend policy suggests that a company does not pay dividends at all, which would not relate to investor experience with earnings volatility since there would be no cash flow through dividends to consider. Hence, while the constant dividend policy provides steady payouts and reduces the link between earnings volatility and dividends, the residual dividend policy actually allows for full exposure to such volatility.