chapter 5

The following dividend information for New York Stock Exchange listed common stocks is reported in The Wall Street Journal. Quarterly Company Dividend Record Date Payable Date Cummings Corp. 50 cents 4/10 5/15 Federal Corp. 85 cents 4/13 5/25 General Electric Corp. 95 cents 4/8 5/21 A buyer of Cummings Corporation on May 10: a. Is entitled to receive the 50-cent quarterly dividend b. Is not entitled to receive the 50-cent quarterly dividend c. Is entitled to receive the 50-cent quarterly dividend if the trade was made for cash d. Is entitled to the 50-cent quarterly dividend if he paid for the stock by May 15

A buyer of Cummings Corporation is not entitled to receive the 50-cent quarterly dividend because the purchase was made on May 10. This was after the stock had already sold ex-dividend (without the dividend). The ex-dividend date is not given but the record date of April 10 is. Stocks sell without the dividend (ex-dividend), on the second business day preceding the record date. This would be two business days prior to April 10, which is more than one month before the customer bought the stock. Even if the purchase was made for cash, which requires a same-day payment, it is still one month too late for the buyer to receive the dividend.

ABC Corporation has issued a call notice on its 5% convertible preferred stock. The preferred stock, which is convertible at $20, is being called at $110 and is currently trading at $111. If ABC's common stock is currently trading at $23, what should an RR recommend to an investor who holds the preferred stock? a.Convert the preferred stock into common stock and sell the common stock b.Sell the preferred stock at the current market price c.Allow the preferred stock to be called d.Continue to hold the preferred stock

A- To determine the best choice for the investor, let's evaluate each possibility separately. 1. The preferred stock may be converted into five shares of common stock ($100 par value ÷ $20 conversion price). The five common shares may then be sold at the market price of $23, which provides the investor with a total of $115. 2. If the stock is sold, the investor will receive the current market price of $111. 3.If the stock is called, the investor will receive the call price of $110. 4. The investor is not able to continue holding the preferred stock since it is being called. By converting and selling the common stock, the investor will be provided with the greatest amount of proceeds.

A client owns 400 shares of stock in a European company. The client receives a cash dividend and tax is withheld by the European country. Which TWO of the following statements are TRUE concerning the U.S. tax implications for the client? I.The taxes paid may be used as a credit II.The dividends are considered a return of capital III.The taxes paid may be used as a deduction IV.The dividend paid is exempt from taxes a.I and III b.I and IV c.II and III d.II and IV

A- U.S. citizens and corporations owning foreign stock may receive dividends from which foreign taxes have been withheld. The investor still owes U.S. income tax on the net dividend. The amount of the foreign tax, however, may be claimed by the investor as a deduction against income, or may be applied as a credit against U.S. income tax

All of the following derivatives are created by an issuer of securities, EXCEPT: a. Call options b. Warrants c. Rights d. Convertible preferred stock

A-Call options are issued by the Options Clearing Corporation (OCC) and not by an issuer of securities. The other products are created by an issuer of securities.

Co. A Co. B Co. C Co. D Earnings per Share $2.00 $6.50 $5.20 $7.80 Dividends $0.10 $2.50 $2.60 $6.00 % of Retained Earnings 95% 62% 50% 23% Percentage of Retained Earnings 95% 62% 50% 23% An investor not concerned with current income, who instead is looking for growth, will most likely choose which of the above companies? a. Company A b. Company B c. Company C d. Company D

A-Company A would best suit those needs as it is probably a growth company since it has the smallest dividend payout ratio and the largest percentage of retained earnings. The company pays out only 5% of its earnings in the form of dividends, retaining 95% to finance its growth.

XYZ corporation has 7,000,000 shares of common stock ($1 par value) authorized, of which 5,000,000 shares have been issued. There are 500,000 shares of treasury stock. The current market price of XYZ is 20. The market capitalization of the outstanding common stock is: a.$90,000,000 b.$7,000,000 c.$5,000,000 d.$4,500,000

A-Outstanding shares are issued shares minus treasury stock (shares repurchased by the company). There are 4,500,000 shares outstanding with a market value of $20.00 per share. Therefore, the market capitalization is $90,000,000.

XYZ corporation has income before taxes of $2 million and received $100,000 in preferred dividends from a company in which it owns 25% of the outstanding shares. If XYZ corporation is in the 34% tax bracket, it will pay taxes of: a. $686,800 b. $926,900 c. $966,000 d. $1,050,000

A-Since XYZ corporation owns 25% of the outstanding shares, it is exempt from paying taxes on 80% of dividends received from the stock. The corporation would need to pay taxes on only $20,000 of the dividends received (20% of the $100,000 in preferred dividends) plus the $2,000,000 of income the corporation earned. Since the corporation is in the 34% tax bracket, the tax would be $686,800. (34% of $2,020,000 = $686,800.)

The stock price of XYZ Corporation has remained stable despite the fact that the company has increased the amount of its dividend. Under these conditions, what would happen to the stock's current yield? a. It would increase b. It would decrease c. It would remain the same d. The effect on current yield cannot be determined without knowing the investor's tax bracket

A-The current yield of a stock is found by dividing the stock's annual dividend by its market price. If the dividend increases while the market price remains the same, the stock's current yield will increase.

A client sells short 1,000 shares of KPL at $46 a share. Fourteen months later the client covers the short and on the same day delivers the stock to close out the short position at $35 a share. For tax purposes, the client will report: a. A short-term capital gain b. A long-term capital gain c. Neither a gain nor a loss since the trade involved a short sale d. A short-term capital loss

A-The gain or loss on a short sale is typically treated as a short-term capital gain or loss, since a holding period for the security is not established. The customer closed out the short position the same day, so the holding period was less than one day. In this example, the client has a short-term capital gain taxable in the year the short sale was covered and the stock was delivered.

A corporation calls for the redemption of 1,000,000 shares of convertible preferred stock. The corporation announces that the convertible preferred will be redeemed at a price of $20 plus an accumulated dividend of 12 cents. Each share of preferred can be converted into 1/2 share of common. The preferred stock is selling at $19. There are 2,000,000 shares of common outstanding. Earnings for the common stock are $2.50 per share. The common stock is selling at 35.75. What will the market price of the preferred stock be if it is selling at parity with the common stock? a. 17.88 b. 19 c. 20 d. 71.50

A-The preferred stock is convertible into 1/2 share of common stock. The common stock is selling for 35.75. Parity (or equality in dollar value) for the preferred stock is 1/2 of 35.75 (17.88).

A company has a noncumulative preferred stock outstanding that pays a $5 dividend per year. If dividends on the preferred stock were not paid last year, but will be paid this year, how much will the preferred stockholder receive? a. $5 b. $10 c. $15 d. $20

A-The preferred stock is noncumulative, which means that if the dividend is not paid, it does not accumulate to the next year. Therefore, the preferred stockholder will receive only $5 for this year

A NYSE-listed stock closed at $72. The next day the stock is ex-dividend 60 cents. To determine if the stock increased or decreased from the close of trading, the price is based on: a. 71.40 b. 71.70 c. 72.60 d. 72

A-The stock will be reduced by 60 cents. The stock must be reduced in price to entirely cover the dividend. Therefore, the stock will open at 71.40 (72 - .60 = 71.40). If the stock closed at 72.50 that day, it will be quoted as an increase of $1.10 (72.50 - 71.40).

Briana Corporation, an existing public company, is offering 500,000 shares of common stock to the public through an underwriting syndicate. The prospectus states that 250,000 shares are being offered by selling stockholders and 250,000 shares are being offered by Briana Corporation. The effect of this offering will be: I.A dilution in the earnings per share II.An increase in the earnings per share III.The number of shares outstanding will increase by 500,000 IV.The number of shares outstanding will increase by 250,000 a. I and III only b. I and IV only c. II and III only d. II and IV only

B- After the offering is completed, there will be 250,000 new shares outstanding (The shares sold by the selling stockholders were already outstanding.) This will result in the earnings per share being diluted because the earnings will now be divided by a greater amount (250,000 shares) of new outstanding stock.

A customer owns foreign securities that were purchased from a U.S. broker-dealer. Which TWO of the following amounts will be reported to the customer concerning the tax treatment of interest and dividends? I.The gross amount of dividends and interest II.The net amount of interest and dividends III.The amount of tax paid to the Internal Revenue Service IV.The amount of tax withheld by the foreign government a. I and III b. I and IV c. II and III d. II and IV

B- Dividends and interest paid to a U.S. investor on foreign securities may be subject to withholding tax by the country from which they were paid. If the investor has securities that paid dividends and/or interest that were subject to foreign tax, the broker-dealer will send the investor a form that will report the gross amount of the dividends or interest, and the amount of tax withheld by the foreign government.

Dividends paid by a corporation to its shareholders are NOT: a. Determined by a corporation's board of directors b. Voted upon by a corporation's shareholders c. In the form of cash or the corporation's stock d. In the form of stock owned in another corporation

B-A corporation can pay a dividend to its stockholders in the form of its own stock, stock owned in another corporation, or in cash. The amount of dividend to be paid is determined by the board of directors. Shareholders do not vote on dividend payments.

The stock of which of the following companies is most likely considered cyclical stock? a.An oil and gas company b.A home appliance company c.A utility company d.A pharmaceutical company

B-A cyclical company is one whose sales correspond to changes in the business cycle and, therefore, will be affected by a recession. Examples of cyclical stock includes the stock of household appliance companies, steel companies, and construction companies. A defensive company is one whose sales are not as affected by changes in the business cycle (i.e., it resists recession). Examples of defensive stock includes the stock of pharmaceutical, health care, tobacco, oil and gas, utility, and supermarket companies.

An investor owns 280 shares of XYZ Corporation. XYZ Corporation pays a 15-cent quarterly dividend. XYZ Corporation announces a 5-for-4 split. The dividend per share is adjusted to reflect the split. How much will the investor receive in dividends each quarter after the split? a. $40.00 b. $42.00 c. $52.50 d. $80.00

B-After the split, the investor would own 350 shares (280 x 5/4 = (280 x 5) / 4 = 350) and would receive $42.00 each quarter (350 shares x $0.12 = $42.00) in dividends. To find the adjusted dividend per share, multiply the inverse of the split by the original dividend of $0.15 ([$0.15 x 4] / 5 = $0.12). Since the dividend is adjusted for the split, the investor would receive the same total dividends after the split as before (280 shares x $0.15 per share = $42).or( 280*5/4 )*(.15*4/5)

Junius Arbor purchased stock in 2002 for $24,000. In April 20XX, Mr. Arbor passed away. His estate valued the stock at $82,000. The stock was willed in equal amounts to his daughter Cathy and his son Bob. Cathy sold her stock on September 2, 20XX for $48,000. Bob sold his stock on May 8, 20XX for $56,000. Which of the following statements is TRUE? a. Cathy has a short-term gain of $7,000 and Bob has a short-term gain of $15,000 b. Cathy has a long-term gain of $7,000 and Bob has long-term gain of $15,000 c. Cathy has a short-term gain of $36,000 and Bob has a short-term gain of $44,000 d. Cathy has a long-term gain of $36,000 and Bob has a long-term gain of $44,000

B-In the case of inherited securities, the value of the securities is determined at the time of death. The heirs are always considered to have long-term holding periods. The capital gains or losses for Bob and Cathy are found as follows: The securities at the time of death were valued at $82,000. Bob and Cathy were willed equal amounts of $41,000 each, establishing a cost basis for both of $41,000. To determine the gain, compare the cost basis to the sales proceeds. Cathy sold her stock for $48,000, creating a $7,000 gain, while Bob sold his stock for $56,000, creating a $15,000 gain.

An individual is interested in an investment that offers annual income, has the potential of appreciating in value if interest rates decline and, in the event that the issuer fails to make a payment, having the missing amount added to future distributions. For this investor, which of the following securities is the most suitable? a. Callable preferred stock b. Cumulative preferred stock c. Participating preferred stock d. Convertible preferred stock

B-Individuals generally purchase preferred stock for income. As with any security that pays a fixed rate, there is the potential for appreciation if interest rates decline. There are several types of preferred stock. Cumulative preferred stock will add all unpaid dividends to a future payment if a cash dividend is to be paid to common shareholders. Participating preferred stock allows the owners to share in the extraordinary earnings of a company. Essentially, participating preferred has a stated dividend, but these shareholders may receive more than that amount based on the profits of the issuing company. Convertible preferred stock allows the owner to convert the stock into a fixed number of common shares. Callable preferred stock allows the issuer to retire (call) the stock in at a predetermined price.

Which TWO of the following statements are TRUE concerning the characteristics of preferred stock? I.The securities do not have a fixed maturity date II.The price of these securities is more volatile than common stock III.The dividend will be paid annually IV.The price will fluctuate based primarily on changes in interest rates a. I and III b. I and IV c. II and III d. II and IV

B-Most preferred stock does not have a maturity date and, therefore, one of the risks of purchasing this type of security is that there is no fixed date when you will receive your principal back. These securities are less volatile than common stock, and the prices of preferred stocks are inversely related to the movement of interest rates, as are bonds. The dividend usually is paid quarterly, not annually

Mr. Brown, a shareholder of XYZ Corporation, reads in the newspaper that XYZ Corporation intends to issue new shares through a rights offering. The terms of the rights offering are as follows: 1. 10 rights plus $10.50 are required to subscribe to one new share of stock 2. Fractional shares become whole shares 3. The record date is Friday, October 17 4. JPMorgan Chase and Bank of America are the transfer agents 5. Goldman Sachs and Morgan Stanley are the standby underwriters Mr. Brown will tender (submit) his rights to: I. JPMorgan Chase II. Bank of America III. Goldman Sachs IV. Morgan Stanley a. I only b. I or II only c. I or III only d. I, II, III, or IV

B-Mr. Brown will tender (submit) his rights to either of the transfer agents, JPMorgan Chase or Bank of America.

An investor has been following XYZ Corp. for several years and feels that the company is poised for some very profitable years. Since she wants to purchase a security that offers a consistent annual distribution and one that benefits from XYZ deciding to pay a significant cash dividend to its common stockholders, she should consider purchasing: a.Cumulative preferred stock b.Participating preferred stock c.Collateral secured bond d.Common stock

B-Participating preferred stock allows the owners to share in the extraordinary earnings of a company. Essentially, participating preferred has a stated dividend, but these shareholders may receive more than that amount based on the profits of the issuing company. Cumulative preferred stock will add all unpaid dividends to a future payment if a cash dividend is to be paid to common shareholders. A collateral secured bond provides the holder with safety due to it being backed by a specific asset of the issuer, however, the issuer will pay no more than the bond's stated rate of interest. Common stock will pay only cash dividends if they are declared by the company's board of directors.

On February 10, an investor sold 100 shares of ABC short at $50/share. The investor covers the position on November 1 by purchasing 100 shares of ABC at $58/share, establishing an 8-point loss. If, on November 15, the investor shorts 100 shares of ABC at $56/share: a. The investor is short 100 shares of ABC against the box b. The wash sale rule has been violated c. The investor has a $200 short-term capital gain d. The investor has an $800 short-term capital loss

B-Reinstating a position within 30 days of realizing a loss is a violation of the wash sale rule. The November 15 short sale creates a new short position in ABC only 15 days after establishing a loss on an original short position in ABC. Therefore, the loss may not be claimed at this time

How would preferred stock most likely be affected by an increase in interest rates? a. Its market value would increase b. Its market value would decrease c. Its dividend would decrease d. There would be no effect

B-Since preferred stock is a fixed-income security paying a fixed dividend each quarter, it is affected by interest rates in the same way as bonds. If interest rates rise, the value of existing bonds and preferred stock will fall. If interest rates fall, the value of existing bonds and preferred stock will rise.

ABC Corporation is paying a $5 yearly dividend on its preferred stock. The market price of the preferred stock is $80. The current yield is: a. 5.55% b. 6.25% c. 7.35% d. 8.25%

B-The current yield on common or preferred stock is found by dividing the yearly dividend by the market price of the stock. In this example, the market price of the preferred stock is $80 and the yearly dividend is $5. This equals a current yield of 6.25% ($5 divided by $80 equals 6.25%).

A convertible preferred stock is convertible at $10, pays a 4% annual dividend, is callable at $110, and is trading at a current market price of $116. Based on these details, what is the parity price of the common stock? a.$10.00 b.$11.60 c.$11.00 d.$12.00

B-The first step in determining the parity price for a convertible security is to find the conversion ratio (i.e., the number of common shares to be received if the preferred stock is converted). The conversion ratio is calculated by dividing the par value of the preferred stock ($100) by the conversion price ($10). As a result, the stock is convertible into 10 shares of common stock ($100 ÷ $10). To find the parity price of the common stock, the current market price of the preferred stock ($116) is divided by the conversion ratio (10 shares). Therefore, the parity price is $11.60 per share.

A stock closes at $37. The next day the stock sells ex-dividend $0.68 per share. At what price will the stock open the next day if it opens at the same level it closed the day before? a. 36.66 b. 36.32 c. 37.00 d. 37.68

B-The price of a stock is reduced by an amount sufficient to cover the dividend. The price will be reduced by 68 cents. Therefore, $37 - .68 = $36.32.

An investor feels the economy is improving and wants to structure her portfolio to focus more on stocks with greater growth potential. She will typically be looking for stocks with which TWO of the following characteristics? I. High price-earnings ratios II. High dividend payout ratios III. Low price-earnings ratios IV. Low dividend payout ratios a. I and II b. I and IV c. II and III d. III and IV

B-The term growth stock applies to a company that has shown a consistent high rate of growth for earnings over a given period. Historically, investors have been willing to pay more for one dollar of earnings for these stocks and they usually sell at higher price-earnings ratios. Since the company is in a growth stage, a large percentage of the profits will be retained by the company resulting in a low dividend payout ratio. Growth stocks have high price-earnings ratios and low dividend payout ratios.

Which of the following stocks would most likely be considered a defensive stock? a. An aerospace stock b. A utility stock c. An airline stock d. An automobile stock

B-Utility, food, beer, candy, pharmaceutical, tobacco, and soft drink stocks would be considered defensive stocks. They offer the investor a greater amount of safety because in periods of recession and adverse economic conditions these companies are the last to be affected.

An individual owns 800 shares of stock at an original cost of $55 per share. If the company distributes a 15% stock dividend, what is the client's cost basis per share? a. $63.25 b. $55.00 c. $47.83 d. $47.75

C-A stock dividend is not a taxable event when received. The investor must adjust her cost basis. The investor would now own 920 shares (800 shares x 1.15). The new cost basis would be $47.83 (original cost of $44,000 [800 shares x $55] divided by 920 shares).

The security with the longest expiration date would normally be a: a. Put b. Call c. Warrant d. Right

C-A warrant generally has an expiration date longer than a put, call, or right. There are some warrants which never expire

Which TWO of the following securities will MOST likely be subject to a withholding tax? I.A bond issued by a U.S. company but sold to U.S. investors II.A bond issued by a foreign company but sold to U.S. investors III.Stock issued by a foreign company but sold to U.S. investors IV.Stock issued by a U.S. company but sold to U.S. investors a.I and III b.I and IV c.II and III d.II and IV

C-Choice (II) is an example of a Yankee bond and choice (III) is an example of an ADR. Dividends and interest paid to a U.S. investor on foreign securities may be subject to a withholding tax by the country from which they were paid. If the investor has securities that paid dividends and/or interest that were subject to a foreign tax, the broker-dealer will send the investor a form that will report the gross amount of the dividends or interest, and the amount of tax withheld by the foreign government.

For tax purposes, corporations may exclude a portion of the dividends received from: I.Municipal bonds II.Corporate bonds of other corporations III.Preferred stocks of other corporations IV.Common stocks of other corporations a. I and II only b. II and III only c. III and IV only d. II, III, and IV only

C-Corporations may exclude a portion of the dividends received from equity investments in other corporations. This includes common stock and preferred stock.

Aglet International, Inc. has pretax income of $2,000,000. In addition, it received dividends of $100,000 from the common stock of a corporation in which it had a 10% interest. If the corporation pays a 34% tax rate, what is its total tax liability? a.$680,000 b.$686,800 c.$690,200 d.$714,000

C-If a corporation owns less than 20% of the distributing company, the corporation is required to pay tax on 30% of the dividends it receives on stock that it owns (70% is excluded). The company would need to add $30,000 (30% of $100,000) to its taxable income. The total taxable income, therefore, is $2,030,000. The tax liability is $690,200 ($2,030,000 times 34% tax rate). If the corporation owned at least 20% of the distributing company, only 20% of the dividends would be taxable.

A corporation calls for the redemption of 1,000,000 shares of convertible preferred stock. The corporation announces that the convertible preferred will be redeemed at a price of $20 plus an accumulated dividend of 12 cents. Each share of preferred can be converted into 1/2 share of common. The preferred stock is selling at $19. There are 2,000,000 shares of common outstanding. Earnings for the common stock are $2.50 per share. The common stock is selling at 35.75. If all shares are converted, how many shares of common stock will be outstanding? a. 500,000 b. 2,000,000 c. 2,500,000 d. 3,000,000

C-If all of the preferred stock were converted into common stock, there will be an additional 500,000 shares of common stock outstanding, (1/2 of 1,000,000 = 500,000.) This, added to the 2,000,000 shares outstanding, equals 2,500,000 shares of common stock

John Jones, a shareholder of XYZ Corporation, reads in the newspaper that XYZ Corporation intends to issue new shares through a rights offering. The terms of the rights offering are as follows:1. 10 rights plus $10.50 are required to subscribe to one new share of stock 2. Fractional shares become whole shares 3. The record date is Friday, October 17 4. JPMorgan Chase and Bank of America are the transfer agents 5. Goldman Sachs and Morgan Stanley are the standby underwriters John chose to subscribe to the rights offering and purchased additional XYZ Corporation common stock on October 16. Based on his latest stock purchase, he will: a. Be permitted to subscribe b. Be permitted to subscribe provided that the trade was executed regular-way c. Not be permitted to subscribe because the stock traded ex-rights on October 15 d. Be permitted to subscribe because the record date has no bearing on when the stock trades ex-rights

C-John would not be permitted to subscribe to the rights offering for the new shares because he purchased the stock on October 16. The stock sold ex-rights on October 15. Therefore, he would not be a stockholder of record for these shares on the record date of October 17.

Ashton purchased 100 shares of XYZ common stock in January 2003, at a price of $25 per share. XYZ pays a quarterly dividend of $.25 per share. Today, XYZ closed at $30 per share. What is the dividend yield of XYZ common stock? a. .83% b. 1.25% c. 3.33% d. 4.00%

C-The dividend yield for a stock is equal to the annualized dividend divided by the current market price. Since dividends are paid quarterly, the annual dividend is $1 per share ($.25 x 4). The annualized dividend of $1 divided by the current market price of $30 per share results in a dividend yield of 3.33%C=-

An investor wishes to establish a tax loss but still wants to own the same security. The customer sells the security and repurchases it two weeks later. The tax loss is: a. Established b. Recognized c. Disallowed d. Amortized

C-The tax loss is disallowed. The customer must wait more than 30 days before repurchasing the same security or any security convertible into the security (a right, option, warrant, or convertible bond). The customer repurchased the same security two weeks later. This is considered a wash sale for tax purposes by the IRS and the loss is disallowed.

An investor owns convertible preferred stock that was originally purchased at $106. The stock is convertible at $25, pays a 5% annual dividend, is callable at $110, and is trading at a current market price of $112. If the common stock is currently trading at $27.75 and the investor decides to convert the preferred stock into common stock, what would be the cost basis per share for the newly acquired common stock? a.$27.75 b.$27.50 c.$26.50 d.$28.00

C-To determine the cost basis of the common stock, the first step is to calculate the conversion ratio (i.e., the number of common shares to be received if the preferred stock is converted). To calculate this, the par value of the preferred stock ($100) is divided by the conversion price ($25). As a result, four shares of common stock are received upon conversion. The cost basis of the newly acquired common shares is found by dividing the original purchase price of the preferred stock ($106) by the number of shares received (4). $106 ÷ 4 = $26.50. Any future gains or losses on the sale of the common stock are based on this price.

A customer sells 100 shares of GM short. GM pays a 5% stock dividend. When the customer covers the short position, the customer will need to deliver: a. 5 shares of GM b. 100 shares of GM c. 105 shares of GM d. None of the above

C-When a customer sells short, the brokerage firm borrows stock to deliver it to the buyer. All cash and stock dividends paid are the responsibility of the customer who sold the stock short. In this example, GM paid a 5% stock dividend. Therefore, a customer who sold 100 shares of GM short would need to deliver 105 shares (100 shares x 5% = 5 additional shares) to cover the short sale.

On February 22, an investor sells ABC stock at $31 for a 3-point loss. On March 10, the investor purchases ABC stock at a price of $27. For tax purposes, the investor's cost basis for the stock purchased on March 10 is: a. 24 b. 27 c. 30 d. 31

C-When the wash sale rule is activated, the investor must add the loss to the new cost of the stock regardless of whether the stock is repurchased at a price that is higher or lower than the original cost. In this example, the investor's cost basis for tax purposes is found by adding the 3-point loss to the new cost of $27.

A corporation is in the 34% tax bracket. Which of the following choices provides the BEST return if the corporation wanted to invest some of its surplus cash? a.A preferred stock paying a 5 1/2% dividend b.A corporate bond yielding 7% c.A common stock paying a 5% dividend d.A municipal bond yielding 5.5%

D- According to the corporate dividend exclusion, corporations may exclude from taxation 70% of eligible dividends received from investments in stock of other corporations. For those corporations owning 20% or more of another corporation's outstanding common or preferred shares, the exclusion increases to 80% of dividends received. To find the after-tax return of each investment, multiply the return on the security by the complement of the tax rate. For the taxable non-equity position, this rate is 66% (100% minus 34%) or .66. For each taxable equity position, we assume an exclusion of 70%. The corporation's effective tax rate on the residual 30% of income from an equity investment, can be calculated by multiplying the corporation's statutory tax rate of 34% by the residual percentage (34% x 30% = 10.2%). The amount the corporation would earn after tax is the complement of 10.2%, which equals 89.8% (.898). The municipal bond interest is tax-free to the corporation. Now we can compare the after-tax return on each security. The after-tax return on the preferred stock is 4.94% (5.5% x .898). The after-tax return on the common stock is 4.49% (5.0% x .898). The after-tax return on the corporate bond is 4.62% (7.0 % x .66) since the corporation must pay the full statutory 34% rate on this non-equity security. The after-tax return on the municipal bond is 5.5% since no taxes are due on the coupon

Co. A Co. B Co. C Co. D Earnings per Share $2.00 $6.50 $5.20 $7.80 Dividends $0.10 $2.50 $2.60 $6.00 % of Retained Earnings 95% 62% 50% 23% An investor has decided to diversify her portfolio into a more defensive position by including utility stocks. Which of the above companies is probably a utility? a. Company A b. Company B c. Company C d. Company D

D- Company D is probably a utility since utility companies usually have a high dividend payout ratio and a low percentage of retained earnings

A company based in Europe with offices located in New Jersey would like to have its stock traded on the NYSE. This most likely will be accomplished through the issuance of: a. Yankee bonds b. Eurodollar bonds c. Bankers' Acceptances d. American Depositary Receipts

D-American Depositary Receipts (ADRs) facilitate U.S. investment in the stock of foreign corporations. When the foreign securities are deposited in a U.S. bank based in that country, a receipt for those securities is issued and traded in the U.S. as if it were the foreign security itself.

Mrs. Jones owns stock from which she received $3,000 in cash dividends. Mr. Jones owns stock from which he received $400 in cash dividends. How much of the cash dividends received are Mr. and Mrs. Jones liable for when filing their joint return? a. 0 b. $400 c. $2,600 d. $3,400

D-Cash dividends received by individuals are fully taxable and, therefore, the entire $3,400 total of dividends is liable for taxes.

Which of the following securities will MOST likely be subject to a withholding tax? a. An initial public offering (IPO) b. A real estate investment trust (REIT) c. A bond issued by a U.S. company that earns income overseas d. Stock issued by a foreign company that earns income in the U.S

D-Choice (d) is an example of an ADR, representing stock issued by a foreign corporation that is traded in the U.S. Dividends paid to a U.S. investor on foreign securities, such as an ADR, may be subject to a withholding tax by the country from which they were paid. If the investor has securities that paid dividends that were subject to a foreign tax, the broker-dealer will send the investor a form that will report the gross amount of the dividends or interest and the amount of tax withheld by the foreign government. The fact that the company earns income in the U.S. is not relevant.

A notice is published stating that RMO 5% convertible preferred stock will be called at $60 per share. The preferred is convertible into 1/2 share of common and is selling in the market at $56 per share. RMO common stock is selling in the market at $110 per share. After the notice appears, the price of the preferred stock will most likely trade in the market at: a. $28 b. $55 c. The same price as before the notice appeared d. A price near $60

D-Converting the preferred stock has a value of $55 ($110 per common share x 1/2 conversion ratio). Since the call price of $60 is more beneficial to the preferred stockholder, the market price of the preferred stock will most likely rise to near $60 (the call price).

Which TWO of the following securities pay a dividend that is NOT eligible for the corporate dividend exclusion? I.Common stock II.Preferred stock III.A real estate investment trust IV.A money-market fund a. I and II b. II and III c. II and IV d. III and IV

D-Corporations are allowed an exclusion on dividends received from investments in common and preferred stock. Real estate investment trusts (REITs) make distributions in pretax dollars. The payout from a REIT normally results from collections of rent or mortgage interest. Money-market fund dividends are distributions of interest earned on short-term debt securities.

Warrants will most likely be issued to: a. Replace outstanding common shares b. Reduce the interest rate on an issue of debentures c. Compensate the underwriting syndicate d. Reduce the issue price of securities

D-Debentures may be issued with warrants attached. This allows the corporation to pay a lower interest rate on the debentures.

A customer owns a mutual fund that invests primarily in foreign securities. Which TWO of the following amounts will be reported to the customer concerning the tax treatment of interest and dividends? I.The net amount of dividends and interest II.The gross amount of interest and dividends III.The amount of tax paid to the Internal Revenue Service (IRS) IV.The amount of tax withheld by the foreign government a. I and III b. I and IV c. II and III d. II and IV

D-If an investor owns a mutual fund that invests in foreign securities, and dividends and interest are paid to a U.S. investor, these earnings may be subject to withholding tax by the country from which they were paid. The broker-dealer will send the investor a form that will report the gross amount of the dividends or interest, and the amount of tax withheld by the foreign government

Which TWO of the following securities would be MOST suitable if interest rates are expected to rise? I. Collateralized Mortgage Obligations II. A bond with short-term maturities III. Preferred stock with a fixed dividend IV. Adjustable-rate preferred stock a.I and III b.I and IV c.II and III d.II and IV

D-If interest rates are expected to rise, the most suitable investments would be those that can be reinvested quickly to take advantage of rising rates, or variable or adjustable-rate securities. Bonds with short-term maturities can be reinvested in bonds quickly with higher rates, and the dividend on adjustment-rate preferred stock would increase since the dividend paid is based on LIBOR or another rate that quickly reacts to changing interest rates.

On June 5, 2013, an investor purchased 100 shares of ABC at 20. On November 10, 2013, he purchased an additional 100 shares of ABC at 12. On January 20, 2014, he sold 100 shares of ABC at 15. For tax purposes, he would have reported a: a. $300 capital gain in 2013 b. $300 capital loss in 2014 c. $500 capital gain in 2014 d. $500 capital loss in 2014

D-In this question, the investor has two positions in ABC stock. Each was purchased at different times and at different prices. When selling a portion of his holdings, unless the investor identifies (on the order ticket) the specific shares he is selling, the Internal Revenue Code requires the use of the FIFO method. Since the investor did not identify the shares sold, it is assumed that the first shares purchased (at 20, in June) were the shares sold. Therefore, the investor would have reported a loss of $500 in 2014.

Ms. Jones, a shareholder of XYZ Corporation, reads in the newspaper that XYZ Corporation intends to issue new shares through a rights offering. The terms of the rights offering are as follows: 1. 10 rights plus $10.50 are required to subscribe to one new share of stock 2.Fractional shares become whole shares 3. The record date is Friday, October 17 4. JPMorgan Chase and Bank of America are the transfer agents 5. Goldman Sachs and Morgan Stanley are the standby underwriters Ms. Jones owns 87 shares of the XYZ Corporation. How many shares can she subscribe to and how much will it cost her? a. 8.7 shares plus $91.35 b. 8 shares plus $84.00 c. 9 shares plus $91.35 d. 9 shares plus $94.50

D-Ms. Jones can subscribe to nine shares at a cost of $94.50. The terms of the rights offering indicate that 10 rights plus $10.50 are needed to subscribe to one new share of stock. Fractional shares become whole shares. She will receive 87 rights. It takes 10 rights to get one new share of stock. 10 rights divided into 87 rights equals 8.7 shares. Since fractional shares become whole shares, Ms. Jones can subscribe to nine shares at a cost of $10.50 a share for a total of $94.50 (9 x $10.50 = $94.50).

Ms. Jones, a shareholder of XYZ Corporation, reads in the newspaper that XYZ Corporation intends to issue new shares through a rights offering. The terms of the rights offering are as follows:1. 10 rights plus $10.50 are required to subscribe to one new share of stock 2. Fractional shares become whole shares 3. The record date is Friday, October 17 4. JPMorgan Chase and Bank of America are the transfer agents 5. Goldman Sachs and Morgan Stanley are the standby underwriters Ms. Jones also owns 87 shares of the preferred stock of the XYZ Corporation. How many additional shares can she subscribe to and at what cost? a. 8.7 shares plus $91.35 b. 9 shares plus $91.35 c. 9 shares plus $94.50 d. Preferred stockholders are not permitted to participate in a rights offering

D-Preferred stockholders are not permitted to participate in a rights offering. Only the common stockholders are permitted.

A common shareholder is not entitled to: a. Vote for the board of directors b. Receive dividends if voted for by the board of directors c. Give or sell shares to anyone she wishes d. Appoint officers of the corporation

D-Shareholders have the right to vote for the board of directors, but not to appoint officers of the corporation.

An investor owns 4,000 shares of common stock that pays a quarterly dividend of 35 cents. If the investor purchases 500 additional shares prior to the first ex-dividend date of the year, what is the investor's expected annual income from the investment? a. $1,400 b. $1,575 c. $5,600 d. $6,300

D-The annual income from the common stock is determined by multiplying the annual dividend by the number of shares owned by the client. Since the additional 500 shares were purchased prior to the first ex-dividend date of the year, the investor is entitled to four quarterly dividends on an ownership level of 4,500 shares. If the annual dividend is $1.40 (35 cents x 4), the annual income would be $6,300 (4,500 x $1.40

A customer owns stock of a corporation that has declared a $1 dividend to holders of record Monday, December 22. If the customer wishes to sell the stock but still be entitled to the dividend, he should sell the stock on: I. Wednesday, December 17, regular-way settlement II. Thursday, December 18, regular-way settlement III. Monday, December 22, cash settlement IV. Tuesday, December 23, cash settlement a. I or III b. I or IV c. II or III d. II or IV

D-The customer should sell the stock Thursday, December 18 on a regular-way settlement basis or Tuesday, December 23 on a cash settlement basis. The ex-dividend date is Thursday, December 18. This is two business days preceding the record date of December 22. This means that a seller on the ex-dividend date will receive the dividend because, on this date, the stock is selling without the dividend. If the stock is sold on December 23 on a cash contract basis (which requires a same-day payment, same-day delivery), the seller will be entitled to receive the dividend. The buyer will not receive the dividend because the last day a buyer can receive the dividend on a cash contract is the record date, which is December 22.

Foremost Corporation has declared a quarterly dividend of 25 cents payable to stockholders of record on Friday, December 1. The dividend will be paid to all stockholders whose names appear on the record books of Foremost Corporation on: a. November 28 b. November 29 c. November 30 d. December 1

D-The dividend will be paid to all stockholders whose names appear on the record books of Foremost Corporation on the record date, which is given in this example as December 1.

The quarterly dividend of ABC company is 32 1/2 cents. The market price is $24.00 a share. What is the current yield? a. 1.35% b. 2.38% c. 4.82% d. 5.41%

D-The formula for computing current yield (also known as the dividend yield) is: Annual Dividend / Market Price of the Stock Since the quarterly dividend is 32 1/2 cents, the annual dividend is $1.30 (32 1/2 x 4 = $1.30). $1.30 divided by the $24 market price equals 5.41%.

A customer owns 50 shares of ABC Corporation. ABC Corporation is engaging in a rights offering. Each existing share receives one right. The terms of the offering are that 10 rights plus $35 is required to buy one new share of stock. If the customer wanted to subscribe to the rights offering, how many additional rights would she need to buy 100 new shares of stock? a.95 b.100 c.350 d.950

D-The terms of the rights offering are that 10 rights are required to subscribe to one new share of stock. If an investor wanted to subscribe to 100 shares of stock, the investor would need 1,000 rights. (10 rights x 100 shares = 1,000 rights.) The investor owns 50 shares of stock and will receive 50 rights from the corporation (one right for each share owned). If the customer wanted to subscribe to 100 shares through the rights offering, the investor would need to purchase an additional 950 rights.

A transfer agent does NOT perform which of the following functions? a. Keep a record of each stockholder's name and shares owned b. Issue and cancel stock certificates c. Resolve problems due to mutilated certificates d. Make sure that outstanding shares do not exceed authorized shares

D-The transfer agent is responsible for issuing new certificates, cancelling old certificates, keeping a record of shareholders and the number of shares each owns, and handling problems that come about in cases of missing, lost, stolen, or mutilated securities. The registrar makes sure that outstanding shares do not exceed authorized shares.

A client owns 3,000 shares of stock in a company headquartered outside the U.S. The client receives a cash dividend and tax is withheld by the country where the company is located. Which TWO of the following statements are TRUE concerning the U.S. tax implications for the client? I.The dividend received is treated as a return of capital II.The taxes paid may be used as a credit III.The dividend paid is exempt from taxes IV.The taxes paid may be used as a deduction a. I and III b. I and IV c. II and III d. II and IV

D-U.S. citizens and corporations owning foreign stock may receive dividends from which foreign taxes have been withheld. The investor still owes U.S. income tax on the net dividend. The amount of the foreign tax, however, may be claimed by the investor as a deduction against income or may be applied as a credit against U.S. income tax.

A customer sells short 400 shares and the company declares a 10% stock dividend. When the customer covers the short position, the customer will be required to deliver: a. 40 shares b. 360 shares c. 400 shares d. 440 shares

D-When a customer sells short, the brokerage firm borrows stock to deliver it to the buyer. All cash and stock dividends declared are the responsibility of the customer who sold the stock short. In this example, the company declares a 10% stock dividend. Therefore, a customer who sold short 400 shares will be required to deliver 440 shares (400 shares x 10% = 40 additional shares) when he covers the short sale.

Bud Jones purchased 100 shares of DEF at 20 on June 16 and passed away on July 27 when the market value of DEF was 25. If the 100 shares of DEF are inherited by Mr. Jones's daughter Mary, what are the tax implications? I. Mary assumes a cost basis of 20 II. Mary assumes a cost basis of 25 III. The holding period for the stock is short-term IV. The holding period for the stock is long-term a. I and III only b. I and IV only c. II and III only d. II and IV only

D-When securities are inherited, the recipient's cost basis is the market value of the securities at the time of the deceased's death. The recipient's holding period for the stock will be long-term, regardless of the deceased's actual holding period.

A corporation declares a 2-for-1 stock split payable on November 30 to holders of record on November 1. The ex-date is December 1. The first day that the stock will trade without a due bill attached is: a. October 28 b. November 29 c. November 30 d. December 1

D-Whoever is the stockholder of record on the record date (Nov. 1) will be credited with the additional shares resulting from the split. If that person liquidates the position prior to the ex-date (Dec. 1), the buyer must receive a due bill upon settlement of that trade. This is because on Dec. 1 the value of the stock will be cut in half. If the buyer does not receive the additional shares, then the position loses half its value on the ex-dividend date. The first day that the purchaser is not entitled to the additional shares is the ex-date, and this is the first day the stock will not trade with a due bill.

A customer wishes to establish a tax loss and sells 100 shares of XYZ Corporation. The loss would not be allowed if the customer, within 30 days: a. Bought an XYZ Corporation put b. Sold an XYZ Corporation straddle c. Bought an XYZ Corporation call d. Sold an XYZ Corporation call

c- The IRS will not allow the loss if the same security or any security convertible into the same security is repurchased within 30 days of the sale. The customer must wait until the 31st day to buy back the security or its equivalent. In this example, the only choice given that could be converted into 100 shares of XYZ Corporation would be a call on XYZ Corporation. The loss would not be allowed if the customer, within 30 days, bought an XYZ Corporation call. This is known as a wash sale.

A corporation's shareholders must vote for: a. Cash dividends b. Stock dividends c. Stock splits d. Stopping dividends

c- The board of directors has control over dividends but must have shareholder approval for a stock split

A stock trades ex-dividend on Monday the 20th. What is the last day an investor can purchase the stock and be entitled to the dividend? a. Monday the 13th b. Thursday the 16th c. Friday the 17th d. Monday the 20th

c- To be entitled to receive the dividend, the stock must be purchased prior to the ex-dividend date. Friday the 17th is the last day an investor could purchase the stock and be entitled to the dividend, since it is the business day prior to the ex-date.

A notice of sale appears showing that RFQ corporation is selling 800,000 units at $60 per unit. Each unit consists of 2 shares of preferred stock and a warrant for 1/2 share of common stock. If all of the warrants are exercised, how many shares will be outstanding? a. 400,000 shares of preferred and 400,000 shares of common b. 800,000 shares of preferred and 400,000 shares of common c. 800,000 shares of preferred and 800,000 shares of common d. 1,600,000 shares of preferred and 400,000 shares of common

d-Each unit was composed of 2 shares of preferred stock and a warrant for 1/2 share of common stock. There will immediately be 1,600,000 (800,000 x 2) shares of preferred outstanding. If the warrants are exercised, there will be 400,000 (1/2 of 800,000) shares of common stock outstanding.