Return on Equity Investments:

• Shareholders have the right to participate in corporate earnings through dividend distributions
  • Dividends are not guaranteed
  • Dividend payments are determined by the corporation’s board of directors

Cash Dividend Dates: Set by corporation (Declared (1) / Record (3) / Payment (4)) / Ex-Dividend Date (2)

• Declaration Date
  • Date on which the dividend is announced
• Payment Date
  • Date on which the dividend (cash or stock) is distributed
• Record Date
  • Date on which a person must own the stock to receive dividend (owner of record)
  • For a buyer to receive the dividend, transaction must settle on, or before, record date
• Ex-Dividend Date
  • 1 business days before the record date
  • Stock begins to sell without its dividend (i.e., at a reduced price or whatever dividend amount is)
  • Regular-way settlement is assumed

Cash trades settle the same business day where regular-way transactions settle in T+2

• Due bill is what seller owes buyer if buyer is entitled something and seller is the one who actually received it
• If the seller fails to deliver the securities by the record date (May 12):
  • The seller remains the stockholder of record and will receive the dividend
  • The buyer is entitled to the dividend if a trade is executed prior to the ex-date (May 11)
  • A due bill must accompany the delivery of stock ensuring the dividend as a receivable for the buyer
    • It’s pretty much a transfer payment that goes to the buyer so the buyer becomes whole

Scenario: A corporation has declared a cash dividend on June 1, payable on July 25 to stockholders of record on Thursday, July 12. Which is true?

• The stock trades ex-dividend on Wed, July 11
• The seller is entitled to the dividend on a trade executed on Tuesday, July 10
• If securities are not delivered by July 12, a due bill most accompany the delivery
• A cash trade can be done as late as July 25 in order for the buyer to receive the dividend 

Stock Dividends:

• The impact of stock dividends
  • If a company chooses to pay a dividend to its shareholders in the form of additional of stock, there is:
    • No economic gain or loss for holders
    • No change to issuer’s capitalization
    • No change to holder’s percentage of equity ownership
• The Tax Treatment of Stock Dividends
  • Additional shares received are generally not taxed as income
  • Investor’s total basis is unchanged, but basis per share is adjusted

Stock Dividend Example:

• Investor owns 100 shares of XYZ at $60/share. XYZ Company declares a 10% stock dividend
• Before dividend: 100 shares, $60/share = $6,000
• After dividend: 110 shares, $54.54/share = $6,000

Calculating Current Yield for Equities

• Also referred to as dividend yield
• Measures the annual income from dividends compared to the stock’s current market price (not the investor’s original purchase price)
• It is based on the annualized dividend

Example:

• A stock is trading at $40/share and has paid a quarterly dividend of $0.30. The current yield for this stock is
• Annual Dividend / Current Market Price
  • (4 * $0.30) / $40 
  • $1.20 / $40 
  • = 3%

Return on Bond Investments

• Bond prices are primarily influenced by fluctuations in market interest rates
  • There is an inverse relationship between bond prices and market interest rates
  • Bond yields and market interest rates move in the same direction
• In order to calculate various returns on bonds, an investor must understand how to determine
  • The interest payable each year
  • The market price of the bond

Nominal and Current Yield on Bonds:

• Nominal yield (NY):
  • Same as coupon, fixed
• Current Yield (CY)
  • Uses the annual interest payments
  • Based on current market price, NOT owner’s original purchase price

Current Yield Calculations:

• Annual Interest / Current Market Price

Yield-to-Maturity (YTM):

• Also referred to as the Basis or simply the yield of a bond
  • Investor’s total overall yield includes
    • Semiannual interest payments
    • Interest earned from reinvesting the interest (compounding or time value)
    • Any gain/loss on the difference between the current value and par value
• Both basis and basis points are measurements of yield
  • Each basis point is .01%; there are 100 bps in every 1%
  • If a bond’s YTM is 4.6%, it is trading at a 4.60 basis
  • If another bond is trading at a yield of 4.75%, it is trading 15 basis points higher

1. A bond’s nominal yield also referred to as its coupon rate
2. To calculate a bond’s current yield, an investor must use its annual interest payment
3. To calculate a bond’s current yield, the current market price of the bond is used, not the investor’s purchase price
4. A bond’s yield-to-maturity is also referred to as its basis or yield 
5. 1.20% is 120 basis points
6. If interest rates are increasing, bond yields are increasing and bond prices are decreasing

Price v. Yield Relationships:

Price v. Yield Example:

• It’ll be what’s above par value because it’s trading at a Premium

• We use the annual interest / current market price to find current yield
• We know that YTM > CY, so it has to be 6.47%

Yield-to-Call (YTC):

• An investor’s yield if a bond is called at par

• For Callable Bonds, always quote the lower of YTC or YTM (referred to as yield-to-worst)
  • When bonds are callable at par and…
    • Selling at a discount, use… yield-to-maturity
    • Selling at a premium, use…yield-to-call

Cost Basis and Capital Events

• Cost Basis
  • Represents the total amount paid to acquire a security
  • Typically includes commissions and other fees paid
• Capital Gains
  • The result of the sale or redemption of an asset if the proceeds exceed the basis (Holding period is measured from trade date to trade date)
    • Short-term: assets that are held for one year or less
      • Taxed at: ordinary rates (usually over 20%)
    • Long-term: Assets that are held for greater than one year
      • Taxed at: Maximum of 20%
• Capital Losses
  • The result of the sale of an asset if the proceeds are less than the basis
  • As it relates to holding period,short-term and long-term loses are defined the same as capital gains 
• A return of capital is when the investor receives some of the original investment back
  • Getting one’s own money back

Total Return

• Applies equally to bond and stock investments by including
  • All cash flows from interests or dividends
  • Plus any appreciation in value
  • Or minus any depreciation
• Total Return = ((End Value – Beginning Value of Asset) + Investment Income) / Beginning Value

Example:

• An investor purchased ABC preferred stock two years ago for $25/share. Over this time, she has received $5 in dividends and the stock is currently trading for $30/share. What is the investors’ total return on her investment?
• Total Return = [($30 – $25) + $5] / $25 = 40%

Measuring Other Investment Returns

• Real Return (Inflation-Adjusted)
  • Rate of Return – Inflation
  • 8% – 1% = 7%
  • 3% – 3% = 0%
  • You want it to be greater than inflation
• Risk-Adjusted Return
  • Rate of Return – Risk-Free Return
  • 8% – 2% = 6%
• Risk-Free Return
  • Rate of return generally found on a US Treasury bill

Average and Indexes

• Investment returns are often compared benchmark or a group of securities
• Narrow-based indexes focus on market segments/sectors, while broad-based indexes attempt to include the entire market, such as:
  • Standard & Poor’s 500 index – comprised mostly of NYSE stocks
    • 400 industrial
    • 20 transportation
    • 40 utility
    • 40 financial
  • Dow Jones Composite – broken down into 3 averages
    • Dow jones industrial – 30 stocks (most widely quoted) GS, DIS, JPM, etc
    • Dow jones transportation – 20 stocks
    • Dow Jones Utility – 15 stocks

Other Averages and Indexes

• Equity Indexes
  • Wilshire Associates Equity Index – Largest index; 5,000 stocks
  • Russell 2000 – focuses on small capitalized stocks
  • Nasdaq composite Index – based on all Nasdaq listed securities
  • Nasdaq 100 – the 100 largest companies listed on Nasdaq
• Bond indexes
  • Barclays Capital and other B/Ds have created indexes based on existing bonds in the market
  • newspaper/publication called Bond Buyer. A well-known publication in the municipal bond market
• Tracking Performance
  • An investor must track how his investments are performing relative to a benchmark or index (e.g., if his investment is up 5%, but the S&P 500 is up 10%…)