Chapter 6

Ex-Dividend Rule

is set by the SRO for the market on which the stock trades (e.g., FINRA). represents the date on which a stock begins to trade without its dividend. A stock will typically trade ex-dividend one business day prior to the record date (i.e., record date minus one business day). So ultimately, an individual who purchases a stock for regular-way settlement (trade date + 2 business days, or T + 2) either on or after the ex-dividend date will not be entitled to the quarterly cash dividend since he will not own the stock by the record date. The ex-dividend date represents the first day that a stock begins to trade without its dividend. Therefore, on the ex-dividend date, the stock's price will be reduced by an amount equal to the dividend to be paid. For example, if a stock paying a $.50 dividend closes at $20 per share on the day before the ex-date, it will open at a price of $19.50 on the ex-dividend date. For any dividend that's in a fractional amount, the reduction must cover the full dividend (i.e., a dividend of $0.12 1 /2 results in a reduction of $0.13).

Return on Bond Investments

when an issuer sells bonds, it's obligated to make consistent interest payments to the bondholders that are allowing it to borrow their money. This fixed rate of interest is also referred to as the bond's coupon rate. Remember, regardless of whether a bond is purchased at a premium, par, of discount price, its interest rate is always based on its par value of $1,000. The basic formula for determining the dollar amount of interest paid each year is the bond's coupon rate multiplied by its par value. Example 1: If a client purchases a 6% corporate bond and pays $875, she will receive $60 per year ($1,000 x 6% = $60). Example 2: If a client purchases an 8% corporate bond and pays $1,000, she will receive $80 per year ($1,000 x 8% = $80). Example 3: If a client purchases a 9% corporate bond and pays $1,100, she will receive $90 per year ($1,000 x 9% = $90).

Using Cash Settlement

A buyer may still obtain the dividend after the normal ex-date by purchasing the security and using a cash (same day) settlement on a date up to, and including, the record date. In the preceding example, if the investor buys for cash as late as Thursday, May 12, she's entitled to the dividend. In this case, the price of the stock is adjusted to reflect buyer's receipt of the dividend. For a cash settlement trade, the ex-dividend date is the business day following the record date

Dividends

Common stock doesn't receive a specific annual dividend; instead, the board of directors decides what dividends (if any) the company is able to pay to its common shareholders. Dividends are paid on a per-share basis. As it relates to dividends, there are three important dates that are set by the paying corporation: Declaration date: The declaration date is the date on which the dividend is authorized. If a company's board declares a $.10 dividend, its stockholders as of a specific date will receive $.10 for each share that they own. Payment date: The payment date is the date on which the declared dividend will be paid. Dividends are usually paid quarterly and are taxable in the year in which they're paid/received. Record date: The record date is the date on which an investor must officially own the stock to be entitled to receive the dividend. For example, on December 1, the board of Widgets, Inc. declares a dividend of $1 per share that's payable on January 3 to shareholders of record on December 15. Any person who is on Widget Corporation's records as a shareholder as of December 15 will receive the $1-per-share dividend on January 3.

Calculating Current Yield (Dividend Yield)

For stock, the current yield is its annual return based on its annual dividend and current price (as opposed to its original price or face value). The formula for calculating a stock's current yield is its annualized dividend by its current market price. For example, if XYZ stock is trading at $50 per share and the stock has a quarterly dividend of $0.25, its current yield is 2%. Since dividends are typically paid quarterly, the $0.25 dividend must be multiplied by four to determine the annualized dividend income. ($.25 x 4)/$50 = $1.00/$50 = 2%

Due Bills

If a trade is executed prior to the ex-dividend date, the buyer is entitled to the dividend. However, if the seller fails to deliver the securities by the record date, the seller will remain as the shareholder of record for the dividend payment. The seller will receive the dividend, but not be entitled to it. Therefore, good delivery rules require a due bill to accompany the stock which creates a liability for the seller and a receivable for the buyer. Using the calendar from the previous example with a record date of Thursday, May 12, if an investor purchases stock on Tuesday, May 10, the transaction will settle in two business days—Thursday, May 12. The buyer will receive the dividend because the transfer agent will be made aware of the name of the new owner in time to change the shareholder's record for the upcoming dividend. Because the stock trades ex-dividend on Wednesday, May 11, from that date forward, the buyer will be able to purchase the stock at a price that doesn't include the dividend. A due bill will be required only if the buyer purchases the stock before the exdate, but the seller delivers the security after the record date.

Stock Dividends

Rather than making a cash distribution, a company may elect to pay a dividend to its shareholders in the form of additional shares of stock. For example, an investor bought 100 shares of Widget, Inc. for $80 per share; therefore, his cost basis is $8,000. If Widget, Inc. declares a 10% stock dividend the investor will be entitled to an additional 10 shares (100 x 10%). Unlike ordinary cash dividends, stock dividends are not taxable until the shares are subsequently sold. Ultimately, the investor will be holding an increased number of shares, but at a reduced price per share. Although this form of distribution is not taxable, the IRS requires the investor to adjust her cost basis on the stock as follows: Original cost basis = $80.00 per share ($8,000 ÷ 100 original shares) Adjusted Cost basis = $72.72 per share ($8,000 ÷ 110 current shares)