1 / 58

BU111 Exam-AID

BU111 Exam-AID. Note: This material is great for review. Agenda. Tax Total Taxable Income vs Taxation of Investment Returns Effective Tax Rates Stocks Going long Bonds Yields and Pricing Short Selling Short Call Margin Buying Margin Call Options PUT and CALL Combined Problem

ishi
Download Presentation

BU111 Exam-AID

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. BU111 Exam-AID Note: This material is great for review

  2. Agenda • Tax • Total Taxable Income vs Taxation of Investment Returns • Effective Tax Rates • Stocks • Going long • Bonds • Yields and Pricing • Short Selling • Short Call • Margin Buying • Margin Call • Options • PUT and CALL • Combined Problem • Keys to Success

  3. Total Tax Payable for a Year • Steps to Success • Begin by determining the individuals total taxable income for the year • Employment Income • + 50% x (Capital Gains – Capital Losses) (if applicable) • + 100 % x Interest Received(if applicable) • Total Taxable Income • Use Tax Tables 1 – 3 to calculate total tax payable for the year • Federal Tax Payable (Table 1) • + Ontario Tax Payable (Table 2) • + Ontario Surtax Payable (Table 3) • Total Tax Payable • 3. DO NOT USE MARGINAL TAX RATES IN ANY SHAPE OR FORM!!!!!

  4. Total Tax Payable for a Year Question #1 Suppose an individual has employment income of $56,000, Capital Gains of. $5,000, Capital Losses of $1,000, and interest received of $10,000 during the 2010 year. What is the total tax payable for the 2010 year? Answer: 1. Determine Total Taxable Income → $56,000 + 0.5 x ($5,000 - $1,000) + $10,000 $68,000 Employment Income + 50% x (Capital Gains – Capital Losses) + 100% x Interest Received Total Taxable Income 2. Use Tax Tables 1 - 3 → Federal Tax Payable (Table 1) + Ontario Tax Payable (Table 2) + Ontario Surtax Payable (Table 3) Total Tax Payable [$6,146 + ($68,000 - $40,971)*0.22] + [$1,874 + ($68,000 - $37,108)*0.0915] + [($4,701 - $4,006) x 0.20] $16,932 (Total Tax Payable)

  5. Marginal Tax Rates • Steps to Success • ***Remember: Marginal Tax Rates are only used to estimate tax owed on investments! • 1. Determine the amount of investment that is subject to tax. • 2. Use Table #4 to determine which marginal tax bracket the individual falls in • - Could be stated (ie: “Investor falls in 26% Federal Tax Bracket) • - If not stated, use the investors “Employment Income” or “Other Sources of Income for the Year” to establish which bracket. • Calculate the Marginal Tax Rate that applies: • Marginal Tax Rate % = Federal Rate % + Provincial Rate % +(Provincial % x Surtax %) • 4. Calculate to tax payable on the investment: • Tax Payable on Investment = [Amount Subject to Tax] x Marginal Tax Rate %

  6. Tax on Net Capital Gains • Steps to Success • Determine the Net Capital Gain • Net Capital Gain = Capital Gains – Capital Loss • Only 50% of the value of a capital gain is subject to tax! • Capital Gain Subject to Tax = 0.5 x [Net Capital Gain] • **Note: IF [Net Capital Gain] = 0 or -, then no tax is owed. • Determine Tax Owed on Capital Gain by multiplying by the investors marginal tax rate! • Tax Owed on Capital Gain = [Capital Gain Subject to Tax] x Marginal Tax %

  7. Example • In 2010 you made two stock market investments. On the 1st investment, you earned a Capital Gain of $10,000. On the 2nd investment you realized a Capital Loss of $5,000. If you have employment income of $60,000 during 2010, what is the tax you owe on JUST your investments?

  8. Answer Step 1: Net Capital Gains = Capital Gains – Capital Losses = $10,000 – $5,000 = $5,000 Step 2: Capital Gains subject to tax = Net Capital Gains x 50% = $5,000 x 50% = $2,500 Step 3: Capital Gains Tax Payable = [Capital Gains subject to tax] x [Investor’s Marginal Tax Rate %] = $2,500 x [22% + 9.15% + (0)] = $2,500 x 31.15% (this is the Marginal Tax Rate derived using $60,000 income) = $778.75

  9. Effective Tax Rate on Capital Gains Recall, the formula for Effective Tax Rate: Effective Tax Rate = Tax Payable/Investment Return In other words “What % of what I made is paid to the government (taxes)” From our Previous Example: Effective Tax Rate = $778.75/$5,000* = 15.575%** * Remember our return is the total dollar amount earned, not the amount subject to tax! ** The Effective Tax Rate on Capital Gains is 50% the marginal rate!! 31.15 x 50% = 15.575%

  10. Tax on Interest Income • Steps to Success • Determine the amount of interest received • Note: The coupon payments on a bond are received in the form of interest! • Determine the amount of tax owed • Note: Interest is 100% taxable • Therefore, Tax owed on interest = [Interest Earned] x [Marginal Tax Rate %]

  11. Example • Assume that you are an Ontario investor that held some bonds in 2010 that paid a total of $900 interest in the form of coupon payments. What is the total tax that you would owe on the interest if this investor is in the highest marginal tax bracket?

  12. Answer Amount of interest received = $ 900 Marginal Tax Rate = 46.41% (using Tax Tables #1-3 and Marginal Rate Formula) Tax Payable = Interest x Marginal Rate = $900 x 0.4641 =$417.69

  13. Effective Tax Rate on Interest Recall, the formula for Effective Tax Rate: Effective Tax Rate = Tax Payable/Investment Return From our Previous Example: Effective Tax Rate = $417.69/$900 = 46.41% ** ** The Effective Tax Rate on Interest is simply the investors marginal rate!

  14. Tax on Dividends • Steps to Success • Calculate the total dividends received • Calculate the amount of dividends subject to tax (gross up 44%; both Fed and Prov) • Amount of Dividends Subject to Tax = 144% x Dividend Amount • Calculate Federal Tax, Provincial Tax, and Surtax separately • -Note: Federal Tax Credit of 18% • -Note: Ontario Tax Credit of 6.4%

  15. Example Elton John made $75,000 playing the piano in 2010. Also, during the year, he earned dividends on his investments totalling $1,500. How much tax does Elton owe on the dividends?

  16. Answer NOTE: ALL TAX RATES DERVIVED FROM $75,000 IN EMPLOYMENT INCOME Federal Tax Payable:Dividend amount = $1500Amount subject to tax = $ 2160 (1500 x 1.44)Fed Tax Payable (22%) = $ 475.20 (0.22 x 2160)Fed Tax Credit (18%) = $ 388.80 (0.18 x 2160)Total Fed Payable = $ 86.40Ontario Tax Payable:Ont Tax (11.16%) = $241.06 (0.1116 x 2160)Ont Tax Credit (6.4%) = $138.24 (0.064 x 2160)Total Ont Payable = $102.82 Ontario Surtax (56%) = $57.58 (0.56 x 102.82)Total Tax Payable = $246.80

  17. Effective Tax Rate on Dividends Recall, the formula for Effective Tax Rate: Effective Tax Rate = Tax Payable/Investment Return From our Previous Example: Effective Tax Rate = $246.80/$1,500 = 16.45%

  18. After-tax Yield • Determine how much cash the investor earned from the investment • Determine how much cash that investor owes in taxes on that investment • **Remember, if there is interest paid (from a margin account), it can be used to reduce the total amount of tax payable because it is tax deductable! • 3. Determine (From Step 1. and Step 2.) what the amount of cash the investor got to keep after all tax and expenses were paid • “How much did the investor REALLY make on this investment?” aka the Amount of $ in their pocket at the end • 4. Take the amount determined in Step 3 and divide by the total amount invested

  19. After-tax Yield - Example Suppose you are an investor that recently made an investment using margin. The investor earned a capital gain of $2,000 and paid interest of $100. The investment required the investor put up $10,000. The investment was held for 3 months. If the investor is in the highest marginal tax bracket, what is the annualized after tax yield on this investment?

  20. After-tax Yield – Example • Calculate Cash Earned From the Investment • = $2,000 (Capital Gain) - $100 (Interest) • = $1,900 • Calculate Cash owed in the form of taxes: • = [ (50% x $2,000) - $100 ] x 46.41% • = $417.69 • Calculate Annualized After-Tax Yield • = [($1,900 - $417.69) / ($10,000)] x (12/3) • =14.82% x 4 • = 59.28%

  21. Stocks – Straight Buy/Sell • Buying Stocks: • Determine the number of shares you are going to purchase. -Cost of Acquiring (“Buy”) = # Shares x Price per Share • Don’t forget commissions! • - Commission in = 2% x [Cost of Acquiring] • Selling Stocks: • Take the number of shares you purchased, and multiply by the price at which you have decided to sell: -Proceeds from Selling = # shares held x Price per Share • Multiply the proceeds from selling the stocks by the commission rate (2%) to determine Commission Out [Cost of Selling]

  22. Bid Vs. Ask Prices • Bid Price:Represents highest amount that an investor is currently willing to pay to acquire a board lot of shares of a particular bond • Ask Price:Represents the lowest amount that an investor is willing to accept (sell) for a board lot of shares or a particular bond • A buyer submitting a market order to buy would pay the current ASK price, and a seller submitting a market order to sell would receive the current BID price

  23. Example • You own 500 shares of XYZ Company Stock that was currently quoted at an 8.50 Bid and an 8.55 Ask. • How much would you receive if you decided to sell your holding? You would receive a BID price of $8.50, therefore: 500 shares X $8.50 = $4250 Less commission $85.00 (2%) =$4,165 • How much would is cost you to purchase an additional 250 shares? You would pay the ASK price of $8.55, therefore: 250 shares X $8.55 = $2137.50 Plus commission $42.75 (2%) = $2180.25

  24. Bonds Steps for Success! • Finding the appropriate price for a bond: • Make rough bond yield of current bond equal to coupon rate of bonds trading at par (current, new)

  25. Example • ABC Company issues bonds with a 8.60% coupon at a price of 97.50. They mature on October 31, 2021. Calculate the rough yield. Assume the bond is purchased Oct 31, 2009 and will be held to maturity. • Rough Bond Yield: (Coupon Rate X Par Value) + (Par Value – Purchase Price) # of years to maturity Purchase price of bond = (1000 x 0.086) + (1000 – 975) 12 975 =88.08 975 = 9.034% **Please note, when a bond is quoted with a price of 97.50, it is saying that its current price is trading at 97.50% of par value. NOT $97.50

  26. Example • Suppose you are considering between 2 bonds. The first bond is a “new” bond, being issued with a stated coupon rate of 12% at par value. This bond matures in exactly 12 years. • The second bond is an old bond. It’s quoted coupon rate is only 8%. It has exactly 14 years to maturity. • How much would you be willing to pay for the old bond? • Let ‘x’ be the purchase price of the bond. .12 = ($1000 x 8%) + ($1000 – x)/14 yrs x .12x = $80 + ($1000 – x)/14 1.68x = $1120 + $1000 – x 2.68x = $2120 x = $791.04 Why is this bond selling for less than par value???

  27. Short Selling Important Points - When you “Short Sell” you are essentially selling something that does not belong to you -This means you are receiving cash (cash inflow) - When an investor decides to make a short sell, he/she is speculating that the price of a stock will fall in value, such that he/she can buy the stock back cheaper and return to the owner at a later date and keep the difference between the two prices in profit - The broker requires that the total amount on deposit (cash in account) must be at least 150% the current market value of the stocks shorted. -This means that at the time of the short sell, must put up 50% of the value of the stocks shorted! -The remaining 100% needed comes from the value of the shares themselves

  28. Short Selling - Continued Important Points - Continued • When the stock price of the shares that were shorted rise, the investor will be required to deposit additional funds (short call) such that the amount of cash in the account is equal to 150% of the current market value. • When the stock price of the shares that were shorted fall, the amount of cash in the account is now greater than the 150% that is required. The investor may choose to withdraw any excess cash from the account

  29. Short Sales Steps for Success! • Number of shares sold short multiplied by current BID price to get proceeds from short sale • Deposit 50% of proceeds from short sale • To cover short, buy back shares at current ASK price • Subtract cost of cover from proceeds from short • Subtract commission in and out to get total profit (loss) from short sale

  30. Short Call - The price of the stock has risen, instead of fallen - Not a good thing during a Short Sale - Thus, amount on deposit with the broker is less than 150% of the CMV of the stock shorted; therefore Short Call is applied - Multiply the new price of the shares by the # of shares you shorted. Multiply this amount by 150% to determine how much SHOULD be on account - Remind yourself how much is currently on account Currently in account = Proceeds from Short Sale + Deposit + Previous Short Calls

  31. Short Call - Continued -The amount of the short call is equal to: Short Call = Cash Required in account – Cash Currently in Account Quick Example to illustrate: Suppose you sold short $10,000 worth of a stock. Your initial security deposit was $5,000 (50%). If the value of the stock you shorted climbs to $20,000, then correct illustration of how to calculate the short call is:

  32. Short- Selling Example April 1st, 2010: Your mom decides to short sell 1000 shares of LLL-T. The most recent quote on LLL-T is BID: $30.00 ASK: $30.10. June 1st, 2010: The price of of LLL-T is now at $35.00/sh. Your mom receives a short call. July 1st, 2010: Your mom decides to cover her short position. LLL-T is currently trading for BID: $25, ASK:$26. a) How much is the short call? b) What is her profit/loss? c) What is the cash balance in her short account after covering?

  33. Short- Selling Example a) How much is the short call? Apr 1st: Sell: 1000 @ $30.00 (Bid) = $30,000 Deposit (50%) = $15,000 Cash in Account: $45,000 June 1st: (Price of LLL-T rises to $35) CMV of Shares (1000 @ $35) = $35,000 Am’t Required (150% of CMV) = $52,500 Amount of Short Call = Amount Req’d – Amount in Account = $52,500 - $45,000 = $7,500

  34. Short- Selling Example b) What is her profit/loss? July 1st: Sell: 1000 @ $30.00 (Bid) = $30,000 2% out: = $600 Buy: 1000 @ $26.00 (Ask) = $26,000 2% in: =$520 Capital Gain: $2,880 Therefore, her total profit on the short sale is $2,880.

  35. Short- Selling Example c) What is the cash balance in her short account after covering? Cash Balance on July 1st, 2010 Proceeds from short Sale: $30,000 Plus: Deposit: +$15,000 Plus: Short Call Deposit: +$7,500 Less: Cost of Covering: - $26,000 Less: Commission in (2%) - $520 Cash Balance in Account: $25,980 **Notice how the commission out (2%) was not included? This is because the commission was paid long ago at the time when we entered the short position. Easiest to consider the commission in as a sunk cost that is paid upfront and unrecoverable

  36. Buying on Margin • Buying on Margin is a form of Leverage • You are borrowing money to make more money!! • When you buy on margin, you are speculating that the stock price will rise • Your broker will offer a set margin requirement. The margin requirement might be 80% for example. • This means that you would put up 80% of the total invested, and he/she would cover the other 20% • Don’t forget, brokers don’t loan for free, they charge a set interest rate (will be stated)! • You must meet the stated margin requirement at all times. If the CMV of the stocks you shorted falls, you may be asked to pay a margin call. If the stock price rises, your broker may offer you more margin 

  37. Margin Call • The broker provides a stated margin requirement. It is very important that you follow that requirement! • If the CMV of the stock that was purchased on margin decreases, the brokers stake in the investment is growing (since the loan is fixed) • Therefore the margin requirement split isn’t being met • You must pay off some of the loan, such that the terms of the agreement are back as stated (this is the amount of the margin call!) • When you pay a margin call, you are reducing the amount of the initial loan…..this has interest implications!!

  38. Example On April 1st, Blythe has $12,000 available and would like to purchase as many shares of UUU-T as possible utilizing full margin from her broker. The margin requirement is 75%, and interest is charged at 10% per year. UUU-T is currently trading for $5.00/share. On June 1st, the price of UUU-T has fallen to $3.50/share. Blythe receives a margin call from her broker and pays it immediately. On August 1st, the price of UUU-T is at $8.00 per share. Blythe decides to exit her margin position at this time. If Blythe is in the highest federal tax bracket, how much is the margin call, and what is the after tax yield on this investment?

  39. Answer • How much is the Margin call? April 1st: 0.75x = $12,000 x = $16,000 (amount available, including loan) Therefore, broker loans Blythe $4,000 $16,000/ $5 = 3,200 shares purchased on margin. June 1st: UUU-T falls to $3.50/share $4000 (brokers loan) / $11,200 (CMV of the shares) = 35.71% The broker is only willing to have a 25% stake, therefore, we must reduce our loan such that he does! 25% = [$4000 – Margin Call] / $11,500 Margin Call = $1,125**New Loan amount (as of June 1st) = $4,000 - $1,125 = $2,875

  40. Answer b) What is the after tax yield on this investment? Sell: 3200 x $8.00 = $25,600 2% Out = $512 Buy: 3200 x $5 = $16,000 2% In = $320 Capital Gain: $8,768 Interest Expense = [10% x $4,000 x (2/12)] + [10% x $2,875 x (2/12)] = $66.67 + $47.92 = $114.59 Tax Payable = [(50% x $8,768) - $114.59] x 46.41% = $1,981.43 After Tax Yield = [$8,768 - $114.59 - $1,981.43] / $12,000 = 55.60%

  41. Example #2 – Margin Buy Suppose on April 1st, 2010, you only had $8,000 and wanted to purchase as many shares of TCK.B-T using full margin available. TCK.B was trading for $5.00 per share at the time. The margin requirement is 80%. On May 1st, 2010, the price of TCK.B-T rises to $10.00 per share. You instruct your broker to take the excess margin available to purchase some call options. Determine the excess margin available

  42. Example #2 – Margin Buy April 1st, 2010 $8000 = 0.8x x = $10,000 Therefore, $2,000 loan. Purchase $10,000 / $5 = 2,000 shares of TCK.B-T using margin.

  43. Example #2 – Margin Buy May 1st, 2010 (TCK.B @ $10) CMV of Shares = $20,000 Therefore, brokers stake = $2,000/$20,000 = 10% *But broker is willing to loan you up to 20% CMV Determine amount of additional margin available: 0.2 = $2,000 + x $20,000 Solving for x, x = $2,000 Therefore, you would have $2,000 available to purchase options Where x = the amount of excess available for withdrawal

  44. Options • Call option  Option to buy stock at a certain price (strike price) in the future • Strike Price of $50 • If current market price is $50  At the Money • If current market price is $60  In the Money • If current market price is $45  Out of the Money • Put option  Option to sell stock at a certain price in the future • Strike Price of $20 • If current market price is $35  Out of the Money • If current market price is $15  In the Money • If current market price is $20  At the Money • Remember that in a question where you purchase an option and exercise it, there will be 3 instances of commissions • Commissions in, out and on the purchase of the option (your premium) • Company issues dividends: Irrelevant, since there is no ownership in the company.

  45. Call Options • CALL options are a contract whereby the holder of the option has the right to BUY the underline security as a specified price. • When you purchase a CALL option, you want the price of the underlying security to rise! • The intrinsic value on a CALL option is: Intrinsic Value = Max { 0, Stock Price – Strike Price} Suppose a CALL option on PCA-T is trading for $3.50. The strike price is $32, and the current price of PCA-T is $33. The intrinsic value = Max { 0, $33 – $32} = $1.00 The time value = $3.50 - $1.00 = $2.50

  46. Example - CALL • On March 1st, 2010, an investor decides to purchase 10 CALLS on TCK.B with a strike price of $42. The premium on the options is $3.00. • On April 1st, 2010, TCK.B is trading at $50/share. The investor exercises his/her options at this time. What is the profit on the call options?

  47. Answer Profit on Calls: Sell: 1000 @ $50 = $50,000 2% out: = $1,000 Buy: 1000 @ $42 = $42,000 2% in: = $840 Gross Profit: = $6,160 Less Premium: = $3,000 2% on Premium: = $60 Capital Gain: $3,100

  48. Put Options • PUT options are a contract whereby the holder of the option has the right to SELL the underline security as a specified price. • When you purchase a PUT option, you want the price of the underlying security to fall! • The intrinsic value on a PUT option is: Intrinsic Value = Max { 0, Strike Price – Stock Price} Suppose a PUT option on PCA-T is trading for $3.50. The strike price is $34, and the current price of PCA-T is $38. The intrinsic value = Max { 0, $34 – $38} = $0.00 The time value = $3.50 - $0.00 = $3.50

  49. Example - PUT • Esteban decided to purchase 20 PUT option contracts of TCK.B. The current price of TCK.B is $31.60/share. The PUT option contracts have a strike price of $33.00. The premiums paid on the options reflect intrinsic value + $2.50 time value. Two months later, Esteban exercises his options. At the time of the exercise, TCK.B was trading for $28.50 per share. What is the profit/loss on the PUT options?

  50. Answer Premium Paid = $1.40 (intrinsic) + $2.50 time value = $3.90 Sell: 2000 @ $33 = $66,000 2% out: = $1,320 Buy: 2000 @ $28.50 = $57,000 2% in: = $1,140 Gross Profit: = $6,540 Less Premium: = $7,800 2% on Premium: = $156 Capital Loss: ($1,416) **Notice that the Capital Loss of $1,416 is better than letting the options expire and losing $7,956!

More Related