SIE Chapter 6-- Investment Returns

Total Return

((Ending Value - Beginning Value) + Investment Income) / Beginning Value

Dividends: Stock Dividends

- % declared reps % of current stock held (100 shares held would get 10 more shares) - shareholder holds more share at less cost per share -- original cost basis = $80/share (8000 / 100 og shares) -- adjusted cost basis = $72.72/share (8000 / 110 shares)

Debt/Bond Indices

- Barclays Capital and other brokerage firms have created number of indices based on debt securities in the market - The Bond Buyer- financial publication that specializes in the municipal market and makes municipal bond indices

Dow Jones Averages

- Dow Jones Industrial Average-- 30 stocks - Dow Jones Transportation Average-- 20 stocks - Dow Jones Utility Average-- 15 stocks

Bond Yield Relationships

- If an investor purchases a bond at par, the nominal yield, current yield, and yield-to-maturity will all be equal. - If an investor purchases a bond at a discount, the highest yield will be the yield-to-maturity, followed by the current yield, with the nominal yield as the lowest. - If an investor purchases a bond at a premium, the highest yield will be the nominal yield, followed by the current yield, with the yield-to-maturity as the lowest.

Other Equity Indices

- Major Market Index consists of 20 well-known, highly capitalized stocks - Nasdaq Composite Index consists of all Nasdaq listed securities, and the Nasdaq 100 consists of 100 of the largest companies that are listed on Nasdaq - Russel Index follows 2,000 small-cap company stocks and is considered the benchmark for the small-cap component of the market

Dividends: Current Dividend yields

- annualized dividend / current market price - ex: $50/share with quarterly div of $0.25 -- $1/$50 = 2%

Bonds: Yield-to-Call (YTC)

- bond's yield if it's called prior to maturity (investor receives call premium if bond is called) - lower between YTC and YTM will be disclosed to investor - if bond trading at discount, YTC > YTM - if bond trading at premium, YTC < YTM

Dividends: Cash settlement

- buyer can still receive the dividend if they use a cash settlement after the ex-date up to and including the record date - the ex-date on these trades is the day following the record date - price reflects the fact that the buyer is receiving the dividend

Return on Bonds

- coupon rate * par value - interest is always based on par value ($1000) - ex: 6% i rate -> $60 per year in interest

Bonds: Yield-to-Maturity (YTM)/ Basis

- everything investor receives over lifetime of bond - aka yield or its basis - calculation is not required on exam includes: 1) semiannual interest payments 2) +/- the difference between par and purchase price 3) interest from reinvesting semiannual coupon payments

Dividends: Ex-Dividend rule

- ex-dividend date is date on which a stock begins to trade without its dividend (usually one business day prior to record date) - if a stock with declared dividend of $0.50 1/2 closes at $20 the day before its ex-dividend day, then the next day (the ex-dividend day) it will open at $19.49 - example: if record date is May 12th, May 11th is the ex-dividend date because one who buys the stock on the 11th won't officially own the stock until the 13th

Capital Gains

- generated when an investment is sold for greater than its cost basis - less than one year is taxed at ordinary income rate - greater than one year is taxed at lower rate (currently 20%)

Capital Losses

- generated when an investment is sold for less than its cost basis - same taxes as cap gains - used as reductions against capital gains

Cost Basis

- total amount that investor has paid to purchase security - includes the commissions and related fees to brokerage paid when purchased - IRS Form 1099 provides useful tax related information

Return of Capital

- when investor receives portion of original investment back - not a taxable event - lowers cost basis since less money is now at risk

Wilshire Associates Equity Index

-consists of stocks that trade on NYSE and NASDAQ -represents dollar value of all stocks and is considered broadest of all indexes and averages

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) A discount B) Par C) 106 7/8 D) A premium

A) A discount 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.

If a bond has a basis of 6.35 and a coupon rate of 6.15%, the bond is selling at: A) A discount B) Par value C) A premium D) A price that cannot be determined from the information given

A) A discount 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.

When an investor compares her portfolio's performance to an average or index, the average or index is considered a(n): A) Benchmark B) Total return C) Unrealized gain D) Return of capital

A) Benchmark 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? A) Cash dividend B) Unrealized gain C) Stock dividend D) Return of capital

A) Cash dividend 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.

When interest rates are falling, the market value of existing bonds will: A) Increase B) Remain stable C) Decrease D) Fluctuate

A) Increase 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.

The Bond Buyer Index is based on which of the following securities? A) Municipal bonds B) Treasury bonds C) Corporate bonds D) Mortgage bonds

A) Municipal bonds Municipal bond indices are created by The Bond Buyer. The Bond Buyer is a financial publication that specializes in the municipal market.

If an investor wants to receive a dividend that's been declared on a stock, she must: A) Purchase it prior to the ex-date B) Sell it after the payment date C) Purchase it prior to the record date D) Sell it prior to the ex-date

A) Purchase it prior to the ex-date 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.

On the ex-date of a cash dividend, the subject security would be: A) Reduced by the amount of the dividend B) Increased by the amount of the dividend C) Unchanged D) Valued at a greater amount

A) Reduced by the amount of the dividend On the ex-date of a cash dividend, the stock would be reduced by the amount of the dividend.

Of the following broad-based indexes, the one with the largest measure of the market is the: A) The Wilshire Associates Equity Index B) Dow Jones Industrial Average C) The New York Stock Exchange Composite Index D) Standard and Poor's 500 Index

A) The Wilshire Associates Equity Index 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.

Crunch Time Fact #2

An investor who buys mutual fund shares will not receive an impending dividend distribution if she purchases on the ex-date (the ex-date represents the date on which the shares will sell without the dividend).

Crunch Time Fact #3

An investor who is buying shares will receive a dividend if her purchase is executed prior to the ex-date

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: A) $66 B) $660 C) $91.88 D) $918.75

B) $660 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 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) 36.32 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.

The market price of XYZ Corporation common stock is $55 and its quarterly dividend is $0.60. What is the stock's current yield? A) 1.1% B) 4.36% C) 2.2% D) 5.3%

B) 4.36% 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).

What's the current yield for a bond that's priced at par and offers a $40 semiannual interest payment? A) 4% B) 8% C) 40% D) 80%

B) 8% 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%.

Which of the following dates represents the first day an investor can purchase a stock and not be entitled to its dividend distribution? A) Declared date B) Ex-date C) Record date D) Payment date

B) Ex-date 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? A) Declared date B) Ex-date C) Record date D) Payment date

B) Ex-date 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.

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: A) Thursday, May 24 B) Friday, May 11 C) Monday, May 14 D) Tuesday, May 1

B) Friday, May 11 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.

A customer buys a 6 3/4% bond at 101 3/4. The yield-to-maturity on the bond is: A) 6 3/4% B) Less than 6 3/4% C) More than 6 3/4% D) Par plus 1 3/4%

B) Less than 6 3/4% 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 purchased a security and receives part of his original investment back, this is considered a(n): A) Stock Dividend B) Return of capital C) Realized gain D) Unrealized gain

B) Return of capital 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.

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? A) 1,000 shares at $36.36 per share B) 1,100 shares at $40 per share C) 1,100 shares at $36.36 per share D) 900 shares at $44 per share

C) 1,100 shares at $36.36 per share 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.

If a stock is sold before the ex-dividend date, but delivered after the record date, it must be accompanied by: A) A letter from the transfer agent B) The signature of the owner of the stock C) A due bill D) A power of attorney

C) A due bill When the selling party delivers a security after the date on which the new owner is entitled to receive a cash dividend, the seller must deliver the security with a due bill attached. The due bill recognizes that the buyer is owed the dividend.

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) Par B) A discount C) A premium D) 105 7/8

C) A premium 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.

Of the following broad-based indexes, the one with the narrowest measure of the market is the: A) Standard and Poor's 500 Index B) The New York Stock Exchange Composite Index C) Dow Jones Industrial Average D) The Wilshire Associates Equity Index

C) Dow Jones Industrial Average 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.

A customer has placed a market order with a broker-dealer. The broker-dealer must: A) Execute at the closing price B) Execute at the quoted price or better C) Execute at the most reasonable price available D) Execute at a price no higher than the last executed price

C) Execute at the most reasonable price available 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 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) Friday the 17th 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.

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? A) The name of the issuer B) The exchange on which the transaction occurred C) The cost basis D) Whether the investor reinvested the funds

C) The cost basis 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.

Which of the following statements is TRUE regarding dividends paid on stock? A) The record date is set by the SRO B) The declaration date will occur after the record date C) The ex-dividend date is not set by the company's board of directors D) All open orders are adjusted on the ex-dividend date

C) The ex-dividend date is not set by the company's board of directors 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: A) Realized gain B) Return of capital C) Total return D) Basis

C) Total return 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.

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? A) While only the stock dividend is taxable when received, the receipt of cash dividends will require the investor to adjust in her cost basis per share. B) Neither form of dividend is taxable. C) 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. D) Both forms of dividends are taxable

C) 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. 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.

What is the ex-dividend date? A) the date a company will pay its shareholders a dividend B) the date that an investor must own the stock to be entitled to the dividend C) the first day that an investor can buy stock without receiving the dividend D) the date on which the company announced that it will pay a dividend

C) the first day that an investor can buy stock without receiving the dividend 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.

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? A) 0 B) $350 C) $400 D) $500

D) $500 Under current tax law, all cash dividends that individuals receive are fully taxable.

For which of the following circumstances is there a required tax payment? A) Unrealized gain B) Realized loss C) Return of capital D) Realized gain

D) Realized gain 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.

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? A) Friday, October 8 B) Thursday, October 7 C) Wednesday, October 6 D) Tuesday, October 5

D) Tuesday, October 5 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.

Standard & Poor's 500 (S&P 500)

approximately: - 400 industrial stocks - 20 transportation stocks - 40 financial stocks - 40 utility stocks

Relationship between prices and yields

as interest rates increase, the prices of existing bonds decrease and, as interest rates decrease, the prices of existing bonds increase

Dividends: Due Bills

the seller owes the buyer of stock the dividend in form of a "due bill" if the buyer purchases the stock before the ex-date, but the seller delivers the stock after the record date

A stock's price has risen due to an overall market increase. This increase in price is considered: A) A non-taxable capital gain B) A taxable capital gain C) An unrealized capital gain D) Amortization

C) An unrealized capital gain 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.

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: A) 5.30% B) More than 5.30% C) Between 5.30% and 5.75% D) 5.75%

A) 5.30% 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%.

Inflation-Adjusted Rate of Return

Actual Return - Rate of Inflation

Bonds: Current Yield

current yield = annual interest payment / current market price - what a bond investor receives each year based on (potential) purchase price - ex: 10% bond-> $100 nominal yield -- if current price = $900 -- current yield = 11.11% -- if current price = $1000 -- current yield = 10% -- if current price = $1100 -- current yield = 9.09%

Risk Adjusted Return

how much investment returns in relation to the risk that was assumed to attain it

Bonds: Nominal Yield

nominal yield = total coupons paid during one year / face value of the bond - same as coupon rate - % of the par value that is paid, doesn't account for the current market price

Risk Free Return

Rate of return found on a U.S. Treasury Bill is generally used as the risk free return

Dividends

- declaration date: date on which dividend is authorized - payment date: date dividend will be paid - record date: date investor must officially own the stock in order to be entitled to receive the dividend

Crunch Time Fact #6

A 5% bond that's trading at 90 has a current yield of approximately 5.6% ($50 ÷ 900).

Which of the following statements is TRUE regarding stock dividends? A) A stock dividend increases the number of shares the holder will own. B) A stock dividend creates a current tax liability when the shares are received. C) A stock dividend can only be paid if the company pays a cash dividend. D) A stock dividend will increase the owner's cost basis per share.

A) A stock dividend increases the number of shares the holder will own. 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.

NYSE Composite Index

Contains all common stock listed on the NYSE divided into 4 sub indexes: industrial, transportation, financial and utility issues.

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? A) 75 shares at $160 B) 100 shares at $96 C) 125 shares at $120.00 D) 125 shares at $96

D) 125 shares at $96 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 increases, the investor's value per share 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).

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? A) 7.0% B) 7.5% C) 8.0% D) 8.3%

D) 8.3% 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.

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: A) 8% B) Less than 8 1/2% C) 8 1/2% D) Greater than 8 1/2%

D) Greater than 8 1/2% 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.

Crunch Time Fact #4

For a cash dividend, a stock's price is reduced on the ex-dividend date.

Crunch Time Fact #9

For small stock dividends, the ex-date is the one business day before the record date

Crunch Time Fact #1

If a stock is paying a $0.50 quarterly dividend and its market price is $40, the dividend yield is 5% ($2.00 annual dividend ÷ $40). - yield = annual dividend / market price

Crunch Time Fact #7

If an investor owns 1,000 shares of ABC at $40 and ABC distributes a 25% stock dividend, after the distribution the investor will own 1,250 shares at $32.

Crunch Time Fact #8

The ex-date is typically one business day before the record date and is the date on which the stock's price is reduced by the amount of the dividend.

Crunch Time Fact #10

The formula for calculating Real Rate of Return is: Actual Return - Rate of Inflation.

Crunch Time Fact #5

The formula for calculating the current yield on a municipal bond is annual interest divided by the market price