- An investor's cost basis in a security is best defined as
Answer: the original value of an asset for tax purposes, adjusted for splits, dividends, and other corporate actions.
Cost basis is the original purchase price of a security, including any commissions or fees. It is used to calculate capital gains or losses when the security is sold. It is adjusted for corporate actions like stock splits and stock dividends.
- An investor's portfolio consists solely of a stock that was purchased for $10,000. It is now valued at $12,000 and has paid $500 in dividends. What is the total return for this investment?
Answer: $2,500
Total return includes all components of return: income (dividends) and capital appreciation (realized or unrealized). Here, the income is $500 and the unrealized capital appreciation is $12,000 - $10,000 = $2,000. The total return is $500 + $2,000 = $2,500.
- Immediately after a company pays a 5% stock dividend, what is the impact on an existing shareholder's total equity value in that company?
Answer: It remains unchanged.
A stock dividend increases the number of shares an investor owns, but the market price per share adjusts downward proportionally. As a result, the total value of the investor's holding remains the same immediately after the dividend is paid. It is not a taxable event until the shares are sold.
- On the dividend payable date, a corporation
Answer: sends the dividend payments to the shareholders of record.
The payable date is the date on which the company actually mails or electronically transfers the dividend payment to the shareholders who were owners on the record date.
- A change in a bond's yield to maturity from 3.50% to 3.75% would be described as an increase of
Answer: 25 basis points.
One basis point is equal to 1/100th of 1%, or 0.01%. Therefore, a change from 3.50% to 3.75% is a change of 0.25%, which is equivalent to 25 basis points.
- What key factor distinguishes a bond's yield to maturity (YTM) from its current yield?
Answer: YTM accounts for the time value of money and the capital gain or loss at maturity.
Current yield is a simple measure of return based on the annual coupon payment and the current market price. Yield to maturity is a more comprehensive measure that considers not only the annual coupon but also the difference between the purchase price and the par value received at maturity, effectively accounting for the time value of money over the life of the bond.
- Which of the following is the most widely used benchmark for the U.S. stock market, representing large-cap companies?
Answer: The S&P 500 Index
The S&P 500 Index is a market-capitalization-weighted index of 500 of the largest publicly traded companies in the U.S. and is commonly used as a benchmark for the overall health of the large-cap U.S. stock market.
- What is the most likely effect on a stock's market price when it goes ex-dividend?
Answer: The price will decrease by approximately the amount of the dividend.
On the ex-dividend date, the stock begins trading without the value of the recently declared dividend. As a result, the market price of the stock typically drops by an amount roughly equal to the dividend per share, as new buyers will not be entitled to receive that payment.
- To be entitled to receive this dividend, an investor must purchase the stock no later than
Answer: Wednesday, October 24
To receive a dividend, an investor must own the stock before the ex-dividend date. The ex-dividend date is typically one business day before the record date. With a record date of Friday, October 26, the ex-dividend date is Thursday, October 25. Since equity trades settle T+1, an investor must purchase the stock by Wednesday, October 24 (which settles Thursday, October 25) to be a shareholder of record by Friday, October 26.
- The significance of the record date in the dividend process is that it is the date on which
Answer: an investor must be listed as an owner on the company's books to receive the dividend.
The record date is the cut-off date used by a company to determine which shareholders are entitled to receive a dividend. To receive the dividend, an investor must be an owner 'of record' on this date.
- An investor buys 200 shares of a stock at $30 per share and later sells all 200 shares at $28 per share. During the holding period, the investor received $1.00 per share in dividends. What is the investor's realized capital gain or loss from the sale?
Answer: A realized loss of $400
A realized capital gain or loss is calculated upon the sale of an asset as the difference between the sale proceeds and the cost basis. The investor's cost basis was 200 shares × $30/share = $6,000. The sale proceeds were 200 shares × $28/share = $5,600. The realized capital loss is $6,000 - $5,600 = $400. Dividends received are considered income and are reported separately from capital gains/losses.
- An investor's initial cost basis in a stock is $6,000 for 100 shares. If the company executes a 3-for-2 stock split, what is the investor's cost basis per share after the split?
Answer: $40
A stock split changes the number of shares and the price per share, but the total value of the holding remains the same immediately after the split. The original basis was $60 per share ($6,000/100). In a 3-for-2 split, the investor receives 3 shares for every 2 they own. They will now have (100 / 2) * 3 = 150 shares. The new cost basis per share is the total cost ($6,000) divided by the new number of shares (150), which equals $40 per share.
- A corporate bond with a 5% coupon is trading in the market at a price of $900. What is the bond's current yield?
Answer: 5.56%
Current yield is calculated by dividing the annual interest payment by the current market price of the bond. The annual interest is 5% of the $1,000 par value, which is $50. The current yield is $50 / $900 = 5.56%.
- An investor is considering purchasing a callable bond that is trading at a significant premium. Which yield calculation would provide the most conservative potential return?
Answer: Yield to call
For a bond trading at a premium, the yield to call (YTC) is lower than the yield to maturity (YTM). Because the bond could be called before maturity, an investor would receive the par value sooner, resulting in a smaller annualized return on the premium paid. Therefore, YTC represents the most conservative (worst-case) yield scenario.
- An investor receives a cash dividend from a common stock holding. For tax purposes, this dividend is typically considered
Answer: ordinary income or qualified dividend income.
Cash dividends paid to shareholders are a form of investment income. Depending on the type of dividend and the investor's holding period, they are taxed at either ordinary income rates or the preferential qualified dividend rates.
- An investor purchases a 10-year Treasury STRIP. How is the return on this investment generated?
Answer: Through the appreciation of the bond from its discounted purchase price to its face value at maturity.
A Treasury STRIP is a zero-coupon bond. It does not make periodic interest (coupon) payments. The investor's return is the difference between the deeply discounted purchase price and the full face value (par) received when the bond matures.
- For a bond trading at a discount, which of the following correctly ranks the yields from lowest to highest?
Answer: Nominal, Current, Yield to Maturity
When a bond trades at a discount (below par), the investor's overall return is enhanced by the price appreciation to par value at maturity. This causes the yields to be ranked from lowest to highest as follows: Nominal Yield (coupon) < Current Yield < Yield to Maturity.
- An investor purchases 100 shares of XYZ common stock at $50 per share. Over the year, XYZ pays a quarterly dividend of $0.25 per share. At the end of the year, the investor sells all 100 shares for $53 per share. What is the investor's total return on this investment?
Answer: $400
The total return is the sum of the capital gains and the income received. The capital gain is ($53 - $50) x 100 shares = $300. The total dividend income is ($0.25 x 4 quarters) x 100 shares = $100. Therefore, the total return is $300 + $100 = $400.
- An investor owns 200 shares of ABC stock with a cost basis of $40 per share. If ABC Corporation declares a 10% stock dividend, what will be the investor's cost basis per share after the dividend is paid?
Answer: $36.36
A stock dividend increases the number of shares an investor owns but does not change their total investment cost. The investor will receive 20 new shares (10% of 200). They now own 220 shares. The original total cost was 200 shares x $40 = $8,000. The new cost basis per share is $8,000 / 220 shares = $36.36.
- A customer is considering buying shares of a mutual fund. The registered representative notes that the fund will pay a large dividend distribution tomorrow and suggests the customer buy the shares today to capture the dividend. This recommendation is
Answer: inappropriate, because the fund's share price will decrease by the dividend amount and the distribution will be a taxable event for the customer.
This practice is known as 'selling dividends' and is a prohibited practice. It is misleading to suggest a customer can profit by buying a fund just before a dividend. On the ex-dividend date, the fund's NAV will drop by the amount of the distribution, so the customer experiences no net gain. Furthermore, the customer will have an immediate tax liability on the dividend received.
