Unit 13 - Investment Returns and Investment Taxation

13.1 - Managing Investment Returns

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Yield is a measurement of...

the amount of income an investor will receive as a percentage of the cost of the investment.

Current Yield (CY) =

Annual income ($) / CMV

NOTE: Pay attention to the questions on yield. A question may provide you with the quarterly dividend. CY is an annual figure.

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Example

ABC Corporation pays a $0.25 quarterly dividend. ABC stock is trading at $20 a share. What is the CY of ABC stock?

0.25 × 4 (four quarters in a year) / 20 = 1 / 20 = 0.05 (5%)

Capital Gains are generated from closing an open position at a ______, and capital losses when you close an open position at a _____

profit, loss

Capital Gains =

Sales proceeds - Adjusted Cost Basis

If the capital gains formula gives you a negative number...

it's a capital loss

Adjusted cost basis

amount paid for a position modified by any adjustments

Example

Your customer purchased 100 shares of ABC Corporation for $22 per share three years ago. Last week, they sold the 100 shares for $25 per share. The capital gain is calculated like this:

sales proceeds ($2,500) - cost basis ($2,200) = $300 gain

What's the difference between realized and unrealized gains?

Realized Gains are actual profits made from selling a position while Unrealized gains are increases in the value of a position you currently hold

Total Return

measure of the return an investor receives from an investment including gains/losses

Total Return =

(Income + Gains/Losses) / Cost Basis

Example

A customer purchased 100 shares of Glengarry Real Estate, Inc., for $20 per share. After holding the stock for one year, they sold the shares for $21 per share. Over the year, the company paid a $0.25 quarterly dividend. What is the customer's total return?

Four $0.25 dividends is $1 in income.

They sold the stock for a $1 gain ($21 ‒ $20).

$1 income + $1 gain = $2

$2 / $20 (cost basis) = 0.1 (10%)

Seabird Airlines, Inc., pays a $0.40 per share quarterly dividend, and shares are currently trading at $32 per share. The current yield for Seabird is

A)

5%.

B)

1.25%.

C)

10%.

D)

2.50%.

A

Your customer Mickey owned 100 shares of Jim's Burger Shack. Mickey purchased the shares three years ago for $55 per share and recently sold the shares for $67. Over the holding period, Jim's Burger Shack paid a quarterly dividend of $0.25. On the sale, Mickey realized which of the following?

A)

$15 per share capital loss

B)

$12 per share capital loss

C)

$12 per share capital gain

D)

$15 per share capital gain

C

A customer purchased ABC stock for $20 per share. The stock is currently trading at $22 per share. The customer currently has which of these?

A)

A $2 unrealized loss

B)

None of these

C)

A $2 realized gain

D)

A $2 unrealized gain

D

Your customer owned 100 shares of the Odiferous Tobacco Co. They purchased the shares one year ago for $60 per share and recently sold the shares for $62. Over the holding period, Odiferous Tobacco paid a quarterly dividend of $0.25. What is your customer's total return?

A)

3%

B)

$3

C)

5%

D)

$5

C

13.2 - Types of Income

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(3) things that make up ordinary income

Earned Income

Investment Income

Passive Income

Earned Income

- salary, bonuses, tips

Investment Income

- dividends and interest payments

Passive Income

- income made from investments (like real estate) that make or lose money passively

Long Term Capital Gains taxation

- positions held for more than a year are considered long term and gains are taxed at a lower rate than ordinary income

While short term capital gains are not technically "Ordinary income"....

They are still taxed as ordinary income

All of the following are taxed as ordinary income except

A)

consultation fees received from a client.

B)

profit made from the sale of a long-held security.

C)

a bonus from an employer.

D)

interest payments from a bond portfolio.

A customer purchased 100 shares of DEF Corporation stock at $25 per share on March 15. On May 25 of the following year, the customer closed the position for $30 per share. The customer realizes which of the following?

A)

A long-term capital gain of $500

B)

Passive income of $500

C)

A short-term capital gain of $500

D)

Earned income of $500

A

A customer purchased 100 shares of DEF Corporation stock at $25 per share on March 15. On May 25 of that year, the customer closed the position for $30 per share. The customer realized which of the following?

A)

Earned income of $500

B)

A short-term capital gain of $500

C)

A long-term capital gain of $500

D)

Passive income of $500

B

13.3 - Using Capital Losses

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Capital losses are not a total loss because.....

they can help an investor reduce their income tax liability

If an investor has losses that exceed gains in a given year, they can use up to $3000 of those losses to

reduce ordinary taxable income

If the investor still has more losses than gains after the $3000 is subtracted,

they can carry those losses into the next tax year

Example

In the previous tax year, the investor has the following:

Capital gains: $24,000

Capital losses: $32,000

After using the capital losses to offset the capital gains, the investor has net losses of $8,000 ($24,000 − $32,000).

The investor may reduce their ordinary income by $3,000 and may carry the remaining $5,000 of losses into the next tax year.

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Wash Sale

Purposely selling a security for tax purposes

Is a wash sale illegal?

No, but attempting to use the losses to reduce taxes is illegal

Example

October 21, 2013, buy 1,000 XYZ at 30

November 17, 2014, sell 1,000 XYZ at 28

At this point the customer has established a loss, but then they do this:

November 23, 2014, buy 1,000 XYZ at 27

Note that the long position in XYZ stock was reestablished a few days after the sale that created the loss. The sale is now considered a wash sale, and the loss may not be used for tax purposes.

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Your customer had $120,000 in ordinary income in the prior tax year. This customer also sold two stock positions: the first for a gain of $47,000 and the second for a loss of $50,000. For that tax year, the customer will pay tax on

A)

$117,000 in ordinary income and zero net gains.

B)

$117,000 in ordinary income and $3,000 in gains.

C)

$120,000 in ordinary income and $3,000 in net gains.

D)

$120,000 in ordinary income and zero net gains.

A

Your customer sold 300 shares of LMN common stock at a loss on March 15. Which one of the following purchases would not create a wash sale if made within 30 days of the date of the loss?

A)

Sell 3 LMN Calls

B)

Buy LMN common stock

C)

Buy LMN convertible bonds

D)

Buy 3 LMN Calls

A