SIE Exam, Chapter 06

On Tuesday May 1, XYX Corporation's Board of Directors announced a dividend payable on Friday, May 25 to stockholders of record on Monday, May 14. The ex-dividend date is:

Friday, May 11th. Further Info: Stocks sell ex-dividend on the first business day preceding the record date. The record date is Monday, May 14. Therefore, the ex-dividend date would be one business day before, or Friday, May 11.

When is a dividend payment made?

On the payment date. Further Info: A company will pay its shareholders a dividend on the payment date. The record date is the date that an investor must own the stock to be entitled to the dividend. The ex-dividend date is the first day that an investor can buy stock without receiving the dividend. The declaration date is the date on which the company announced that it will pay a dividend.

A bond has a 6% coupon and is trading at a 6.78% basis. The bond is trading at which of the following price levels?

A discount. Further Info: Basis is a different method of expressing yield to maturity. In this case, the yield to maturity is greater than the coupon rate. The only time a client's yield to maturity is greater than the coupon is when the bond has been purchased at a price less than par (lower price means higher yield). Therefore, the bond must be trading at a discount.

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?

Friday the 17th. Further Info: 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.

For which of the following circumstances is there a required tax payment?

Realized gain. Further Info: Taxes are paid on realized capital gains; however, unrealized capital gains or losses (paper profits or losses) have no impact on the investor's tax situation. Capital or realized gains are generated when an investment is sold for a greater value than its cost basis. Return of capital occurs when an investor receives a portion of her original investment back. Since this return is not considered either income or a capital gain, it's not a taxable event.

On the ex-date of a cash dividend, the subject security would be:

Reduced by the amount of the dividend. Further Info: On the ex-date of a cash dividend, the stock would be reduced by the amount of the dividend.

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?

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

An individual received $500 in dividends from the common shares that she owns of an oil company. How much of this dividend income is subject to taxation?

$500.00. Further Info: Under current tax law, all cash dividends that individuals receive are fully taxable.

Wilsons Chemicals bonds have a nominal yield of 6.6%. They closed the previous day at 91 7/8. An owner of 10 bonds will receive a yearly interest payment of:

$660.00. Further Info: A nominal yield of 6.6% for a corporate bond with a $1,000 par value equals $66 in interest payments. If an investor owns 10 bonds, he will receive an annual interest payment of $660.

A customer purchases 10 M Dade Co. Florida 7.50% G.O. bonds at a 9.50 basis. How much interest will she collect each year?

$750. Further Info: 10 M equal's $10,000 par value of bonds (the symbol M refers to thousands). The coupon rate is 7.50%. Therefore, the annual interest is $750 ($10,000 x 7.50%).

A customer owns 1,000 shares of XAM at $40 a share. If XAM declares a 10% stock dividend, what is the adjusted cost basis per share?

1,100 shares at $36.36 per share. Further Info: With a stock dividend, the number of shares owned will increase. In this case of a 10% stock dividend, the investor will receive an additional 100 shares (1,000 x 10%), but the cost basis per share will be reduced for tax purposes. The cost basis per share is adjusted as follows: $40,000 total investment ÷ 1,100 shares = $36.36. Other than making the adjustment to the cost basis per share, the IRS does not consider a stock dividend as a taxable event.

XYZ company is paying a 25% stock dividend to its common stockholders. If an investor owns 100 shares at $120.00 before the stock dividend, how many shares will the investor own and at what price per share after the dividend is paid?

125 shares at $96.00. Further Info: As the result of a stock dividend, an investor will own more shares of the company. In this question, the investor will receive 25 additional shares, which brings the total to 125 shares (100 x 25% = 25 new shares + 100 original shares). Since the number of shares owned, the price of the stock will fall. An important concept of a stock dividend is that stockholders will neither make nor lose money. In other words, the investor's overall ownership position will not change. For that reason, the new price per shares is $96 (100 shares x $120 = $12,000 investment before the dividend, and $12,000 ÷ 125 shares after the dividend = $96).

The current yield on a municipal bond with a coupon rate of 4.50%, purchased at par and currently trading at $1,055, is:

4.26%. Further Info: The current yield is found by dividing the yearly interest payment of $45 by the market price of $1, 055. This equals 4.26%. The fact that the bond was purchased at par is not relevant.

The market price of XYZ Corporation common stock is $55 and its quarterly dividend is $0.60. What is the stock's current yield?

4.36%. Further Info: A stock's current yield is found by dividing the annual dividend by the current market price of the stock. In this example, the stock's annual dividend is found by multiplying the $0.60 quarterly dividend by 4, which is $2.40. Therefore, the current yield is 4.36% ($2.40/55).

An investor purchases a 20-year 5.30% bond at par value that will yield 5.75% if called at the first call date in five years. The yield to maturity on the bond is:

5.30%. Further Info: The bond has a coupon rate (nominal yield) of 5.30%. If the bond is purchased at its par value and is not called, but held to maturity, the bond's yield will be the same as the coupon rate, which is 5.30%.

What's the current yield for a bond that's priced at par and offers a $40 semiannual interest payment?

8%. Further Info: To calculate the current yield on a bond, the annual interest payment is divided by the current market price. Since this bond has a $40 semiannual interest payment, an investor will receive $80 per year. The $80 of annual interest is divided by the bond's $1,000 par value; therefore, the current yield is 8%.

A company has $50,000,000 par value convertible bonds outstanding. The coupon rate is 8%. The bonds are currently selling at 96. What is the current yield?

8.3%. Further Info: To find the current yield of the bonds, divide the yearly interest paid on the bonds by the current market value of the bonds. The yearly interest is $80. The market value of a bond is $960. Therefore, the current yield equals 8.3% ($80 divided by $960 equals 8.3%). The fact that these are convertible bonds is not relevant.

If a bond has a basis of 6.35 and a coupon rate of 6.15%, the bond is selling at:

A discount. Further Info: Bonds may be quoted based on their yield-to-maturity, which in this example is 6.35 (basis and YTM are synonymous). Since the bonds has a nominal yield (coupon rate) of 6.15%, which is lower than the 6.35% YTM, the bond is selling at a price that is below the par value of $1,000 (i.e., a discount). On the other hand, if the yield-to-maturity was lower than the nominal yield, the bond would be selling at a premium.

A bond has a 6% coupon and is trading at a 5.78% basis. The bond is trading at which of the following price levels?

A premium. Further Info: Basis (or yield basis) is a different method of expressing yield to maturity. In this case, the yield to maturity is lower than the coupon rate. The only time a client's yield to maturity is below the coupon is when the bond has been purchased at a price greater than par (higher price means lower yield). Therefore, the bond must be trading at a premium.

Which of the following statements is TRUE regarding stock dividends?

A stock dividend increases the number of shares the holder will own. Further Info: The only true statement is that a stock dividend increases the number of shares the holder will own. A stock dividend reduces the cost basis per shares of an investor's overall stock position. The tax liability for the additional shares received is only realized when the shares are subsequently sold. A company can pay a stock dividend regardless of whether a cash dividend has been paid.

A stock's price has risen due to an overall market increase. This increase in price is considered:

An unrealized capital gain. Further Info: The increase in the stock's price is considered an unrealized capital gain or appreciation. A capital gain is only realized if an asset has increased in value and it is subsequently sold at that higher price.

When an investor compares her portfolio's performance to an average or index, the average or index is considered a(n):

Benchmark. Further Info: Investors often compare the performance of their portfolio to a given benchmark. The benchmark could be an average or index that monitors the performance of a group of securities.

A tax payment is required for which of the following events?

Cash dividend. Further Info: Cash dividends are taxable in the year in which they are received. However, any tax implication for a stock dividend is delayed until the additional shares are subsequently sold. Taxes are paid on realized gains, but unrealized capital gains or losses (paper profits or losses) have no impact on an investor's tax situation. Return of capital occurs when an investor receives a portion of her original investment back. Since this return is not considered either income or a capital gain, it's not a taxable event.

Of the following broad-based indexes, the one with the narrowest measure of the market is the:

Dow Jones Industrial Average. Further Info: The Dow Jones Industrial Average contains only 30 stocks. The Wilshire Index represents the dollar value of all the stocks and is considered the broadest of all indexes and averages. The S&P 500 Index contains 500 stocks, while the NYSE Composite Index consists of all of the common stocks that are listed on the NYSE.

Which of the following dates represents the first day an investor can purchase a stock and not be entitled to its dividend distribution?

Ex-date. Further Info: The ex-date is the first date on which a stock trades without its dividend included in the price. For regular-way trades (those that settle in two business days), the ex-date is one business day prior to the record date. For a purchaser to receive a dividend distribution, she must buy the stock (execute the trade) by no later than the business day prior to the ex-date.

A corporation will be paying a cash dividend to its shareholders. On what date will the market price of the stock be reduced?

Ex-date. Further Info: The ex-date is the first day that a stock trades without its dividend included in its price. On the ex-date, the stock's price is reduced by the amount of (or enough to cover) the dividend.

A customer has placed a market order with a broker-dealer. The broker-dealer must:

Execute at the most reasonable price available. Further Info: Market orders are executed immediately after being received. Broker-dealers must use reasonable diligence to execute market orders at the best price at the time they are received. For an order to be executed at a specific price or better, it must be entered as a limit order.

A company is offering $200,000,000 of 8 1/2% bonds due July 1, 2038 at 99 1/2% of par value. The yield-to-maturity on the bonds is:

Greater than 8 1/2%. Further Info: The 8 1/2% bonds are being offered at a discounted price of 99 1/2% of their $1,000 par value. An investor who purchases the bonds at the offering price ($995) and holds the bonds to maturity will receive the par value of $1,000. Therefore, investor will have a yield-to-maturity that is greater than the coupon rate (nominal yield) of 8 1/2%. Remember, if a bond's price is low (below par), then its yield is high.

When interest rates are falling, the market value of existing bonds will:

Increase. Further Info: Interest rates and bond prices have an inverse (opposite) relationship. If interest rates are falling, the market value of existing bonds will increase. Conversely, if interest rates rise, existing bond prices will decrease.

A customer buys a 6 3/4% bond at 101 3/4. The yield-to-maturity on the bond is:

Less than 6 3/4%. Further Info: The customer bought the bond at 101 3/4, which is at a premium over the $1,000 par value of the bond. If she holds the bond to maturity, she will only receive $1,000. Therefore, her yield-to-maturity will be less than the nominal yield (coupon rate) of 6 3/4%. Remember, if a bond's price is high (above par), then its yield is low.

If an investor wants to receive a dividend that's been declared on a stock, she must:

Purchase it prior to the ex-date. Further Info: The ex-date is the first day that a stock trades without its dividend included in its price. In order to receive the dividend, an investor must purchase the stock (execute the trade) by no later than the business day prior to the ex-date.

If an investor purchased a security and receives part of his original investment back, this is considered a(n):

Return of capital. Further Info: A return of capital occurs when an investor receives a portion of his original investment back. Since this return is not considered either income or a capital gain, it's not a taxable event.

Of the following broad-based indexes, the one with the largest measure of the market is the:

The Wilshire Associates Equity Index. Further Info: The Wilshire Index represents the dollar value of all the stocks and is considered the broadest of all indexes and averages. The Dow Jones Industrial average contains only 30 stocks. The S&P 500 Index contains 500 stocks, while the NYSE Composite Index consists of all of the common stocks that are listed on the NYSE.

An investor purchases a security and subsequently sells it. In order to determine a gain or loss on the investment, which of the following is required?

The cost basis. Further Info: To determine the gain or loss on an investment, the investor must calculate her cost basis in the security. Basis represents the total amount that an investor has paid to purchase a security. The calculation typically includes the commissions or other fees which are paid to the brokerage firm when the securities are purchased. Ultimately, the difference between the cost basis and sale price determines the amount of the realized gain or loss on the investment.

If a bond is currently selling at a premium, then:

The current yield is lower than the nominal yield. Further Info: Bond yields and prices have an inverse (opposite) relationship, meaning that as one increases, the other would decrease. Therefore, if a bond is selling at a premium (above par), its current yield would have to be lower than its nominal yield. For example, an investor owns an 8% bond trading at $1,100. The nominal yield is 8%. The current yield is found by dividing the annual interest by the market price. An 8% bond pays $80 per year assuming a par value of $1,000. Therefore, the current yield is 7.27%. $80 / $1,100 = 7.27%.

Which of the following statements is TRUE regarding dividends paid on stock?

The ex-dividend date is not set by the company's board of directors. Further Info: When a stock goes ex-dividend, its price is reduced by an amount sufficient to cover the dividend. Ex-dividend dates are set by the SROs, based on settlement rules for the stock. Only orders beneath the current market price are adjusted, not all open orders. The declaration, record, and payable dates are set by the company's board of directors. The declaration date occurs before all other events/dates.

The cash flow received from dividends and/or interest, plus any appreciation or depreciation in the value of an investment, is referred to as the:

Total return. Further Info: The total return calculation takes into account all of the cash flow received from dividends and/or interest, plus any appreciation or depreciation in the value of the investment. This return is expressed as a percentage and is typically calculated over a period of one year.

The record date for a company's cash dividend is Thursday, October 7. What is the latest date a customer may purchase the stock for regular-way settlement in order to receive this dividend?

Tuesday, October 5th. Further Info: The ex-dividend date is the first day on which a stock trades without its dividend. It is typically one business day prior to the record date, which in this question, is Wednesday, October 6. For a buyer to receive the dividend, the transaction must settle on or before the record date of Thursday, October 7. If a person purchases the stock on or after the ex-dividend date, he is not entitled to the dividend since regular-way settlement takes two business days and that would be after the record date. For the customer in this question to be entitled to the cash dividend, the latest date he may purchase the stock for regular-way settlement, must take place on the business day before the ex-dividend date, which is Tuesday October 5. Note; If the question does not state the type of settlement, assume regular-way.

A corporation may choose to pay its shareholders with cash dividends or stock dividends. Which of the following statements concerning the tax status of these events is the most accurate?

While only the cash dividend is taxable when received, the receipt of stock dividends will require the investor to adjust her cost basis per share. Further Info: Only cash dividends are taxable in the year in which they are received. The payment of a stock dividend increases the number of shares held by each shareholder. Since the stock's price will fall in the market, the IRS does not consider there to be a taxable event. However, shareholders are required to adjust their cost basis per share.