UNIT 20 QBANK Flashcards
Which of the following best describes the calculation for gains or losses for tax purposes?
A) Proceeds plus cost basis
B) Proceeds minus dividend, plus cost basis
C) Proceeds minus cost basis
D) Proceeds plus dividends, minus cost basis
C) Proceeds minus cost basis
Explanation
Proceeds minus cost basis equals capital gains. The dividends are not part of the calculation for capital gains.
All of the following are taxable to the investor except
A) stock dividends.
B) semiannual interest payments.
C) cash dividends.
D) capital gains distributions.
A) stock dividends.
Explanation
A stock dividend is payment of additional shares of the issuer to the stockholder rather than payment of cash. The price of the stock is adjusted so that the total value of the outstanding stock is the same before and after the dividend is paid. Stock dividends are thus not taxable.
Benjamin Jackson bought 100 shares of XYZ two years ago at $10 per share. The stock paid a $0.50 dividend each year and he sold the stock for $11. What percent was his total return?
A) 15%
B) 20%
C) 5%
D) 10%
B) 20%
Explanation
The formula for total return is dividends plus capital gains divided by amount invested.
Which of the following is a benchmark for large cap stocks?
A) Standard and Poor’s 500 Index
B) Dow Jones Utilities Index
C) Wilshire 5000
D) Russell 2000® Index
A) Standard and Poor’s 500 Index
Explanation
The Standard and Poor’s 500 Index is an index of 500 large companies.
All of the following are true regarding market indexes except
A) they can demonstrate the overall direction of the market.
B) they can be used to compare against the performance of one’s portfolio.
C) they are performance standards investors can monitor.
D) they track single stocks rather than hypothetical portfolios.
D) they track single stocks rather than hypothetical portfolios.
Explanation
Indexes such as the DJIA or the S&P 500 are hypothetical portfolios, not single stocks. While there’s no single standard or benchmark, an index can be used as a performance standard one can monitor and therefore judge the performance of a portfolio or investment against. When we refer to the stock market’s performance in general, we are most likely referring to the performance of an index or average that tracks stocks or bonds. These benchmarks can serve as an indicator of the overall direction of the market as a whole, or the direction of individual market sectors.
Your client, Dana McCann, just purchased a 20-year City of Salt Lake School District bond for $800. The bond has a stated rate of 4%. The current yield is
A) 3%.
B) 2%.
C) 6%.
D) 5%.
D) 5%.
Explanation
The formula for current yield is the stated rate (coupon rate) divided by the current market price: $40 divided by $800, which in this case equals 5%.
Current yield equals
A) the market priced divided by the annual income.
B) the par value divided by the stated rate.
C) the stated rate divided by the par value.
D) the annual income divided by the market price.
D) the annual income divided by the market price.
Explanation
Current yield equals the coupon rate (annual income) divided by the current market price. This is a very common formula on the test.
Which of the following is a benchmark for small cap stocks?
A) Standard and Poor’s 500 Index
B) Wilshire 5000
C) Russell 2000® Index
D) Dow Jones Industrial Average
C) Russell 2000® Index
Explanation
The Russell tracks 2,000 small company stocks.
An investor notices that a bond originally bought at 95 some years ago is now trading at a price of 88. The investor sells the bond, then buys it back the next day for 88.5 with the intention of declaring a loss from the original purchase and sale on this year’s tax return. This would be known as
A) matched orders, and taking the loss is prohibited.
B) a wash sale, and taking the loss is prohibited.
C) pegging and is taking the loss allowed.
D) supporting, and taking the loss is allowed.
B) a wash sale, and taking the loss is prohibited.
Explanation
Quickly repurchasing a security that was just sold for a loss is recognized as having the intention to take advantage of the loss for tax purposes but not lose the income or potential for future gains from the security. This is known as a wash sale and taking the loss is prohibited. For the loss to be allowed, the investor must wait at least 30 days before repurchase. Matched orders, pegging, and supporting are all prohibited activities meant to manipulate stock prices.
What are the two basic types of return on an investment?
A) Dividends and interest
B) Interest and principal
C) Short term and long term
D) Capital gains and income
D) Capital gains and income
Explanation
Upon the purchase of a security, the investors may receive dividends or interest, which are forms of income, or they may sell the security for a different price than was paid for it, which represents a capital gain or loss.
Your client, Soren Aland, buys a 4% XYZ corporate bond. If his current yield is 5%, he bought the bond at
A) a premium.
B) a discount.
C) par.
D) above par.
B) a discount.
Explanation
A bond purchased at a discount will have a current yield above the coupon rate.
Shelby Bogden, your client, purchased a 6% corporate bond with a current yield of 5%. The bond was purchased at
A) below par.
B) a discount.
C) a premium.
D) par.
C) a premium.
Explanation
A bond purchased at a premium will have a current yield below the coupon rate.
Which of the following regarding income is true?
A) Salary or bonuses are portfolio income; interest and dividends are investment income.
B) Salary, bonuses, interest, and dividends are all investment income.
C) Salary, bonuses, interest, and dividends are all portfolio income.
D) Salary or bonuses are earned income; interest and dividends are investment income.
D) Salary or bonuses are earned income; interest and dividends are investment income.
Explanation
While someone’s salary or bonus would be earned income, investment income is that which is earned from one’s investments. Sometimes called portfolio income, it would include dividends, interest, and capital gains derived from the sale of securities.
An investor purchased 100 shares of LMN in 2013 at a price of $40 per share. Soon after, the LMN declared a 25% stock dividend. Three years after the shares were purchased, they were sold at $50. Which of the following statements are correct?
I. The adjusted cost basis of the shares is $30.
II. The adjusted cost basis of the shares is $32.
III. There is a short-term capital gain on all the shares sold.
IV. There is a long-term capital gain on all the shares sold.
A) II and III
B) I and IV
C) II and IV
D) I and III
Explanation
When a company declares a stock dividend, the cost basis per share is always reduced. The customer will receive 25 new shares (100 shares × 0.25 = 25). The computation is the original total cost $4,000 (100 × $40) divided by the new number of shares 125 (100 + 25). Four-thousand dollars divided by 125 shares equals a new cost basis per share of $32. The holding period for capital gain or loss (short or long term) is always from the original purchase date. In this case, because the shares were sold three years later at 50, the gains are long term.
When a bond is purchased at a discount the current yield will be
A) higher than the coupon rate.
B) lower than the fixed rate.
C) lower that the stated rate.
D) the same as the nominal rate.
A) higher than the coupon rate.
Explanation
The coupon rate, the stated rate, the fixed rate, and the nominal rate all mean the same thing. It is the amount the bond will pay each year. On a discount bond the current yield is always higher than the coupon rate.
The MSCI-EAFE Index tracks which of the following?
A) Mid-cap stocks
B) Corporate bonds
C) Municipal bonds
D) Foreign equities
D) Foreign equities
Explanation
Maintained by MSCI Inc., the Europe, Australasia, and Far East (EAFE) Index is designed to track equity markets of developed economies, excluding the United States and Canada.
Earned income includes which of the following?
A) Child support paid to a divorced spouse
B) A year-end bonus
C) Interest income earned on a bond
D) Dividends earned on a mutual fund
B) A year-end bonus
Explanation
Earned income includes wages, salary, tips, bonuses, and income from active participation in a trade or business.
For tax purposes, investment income is
A) normally taxed as ordinary income.
B) always taxed at the highest ordinary income tax rate.
C) always taxed at the capital gains tax rate.
D) never taxable at ordinary income tax rates.
A) normally taxed as ordinary income.
Explanation
Investment income is that which is earned from one’s investments. Sometimes called portfolio income, it would include dividends, interest, and short term capital gains derived from the sale of securities. Investment income is included in ordinary income for income tax purposes. Long-term capital gains are taxed at the capital gains tax rate.
Regarding the taxation of gains on securities, all of the following are true except
A) short-term gains are taxed at less favorable ordinary income tax rates.
B) long-term gains are taxed at more favorable long-term rates.
C) capital gains are associated with the sale of securities and other real assets.
D) gains on securities for a position held at least 12 months are not taxable.
D) gains on securities for a position held at least 12 months are not taxable.
Explanation
Investment income, which includes capital gains realized on securities positons, is taxable. Depending on how long a security was held, the gains might be taxable at the investor’s ordinary income tax rate (for short-term gains) or at a more favorable long-term rate if the position was held for longer than 12 months.
When a bond is purchased at a premium, the current yield will be
A) higher than the fixed rate.
B) higher than the stated rate.
C) the same as the nominal rate.
D) lower than the coupon rate.
D) lower than the coupon rate.
Explanation
The coupon rate, the stated rate, the fixed rate, and the nominal rate all mean the same thing. It is the amount the bond will pay each year. On a premium bond the coupon rate is always higher than the current yield.
