Series 7 Exam Question 133: Answer and Explanation

Question: 133

Ms. Hudson purchased a 4-percent TUV corporate bond at 90 with 20 years to maturity. Eleven years later, Ms. Hudson sold the bond at 92. What is the gain or loss?

• A. $20 gain
• B. $20 loss
• C. $35 gain
• D. $35 loss

Correct Answer: D

Explanation:

D. Since the bond was purchased at a discount, this is an accretion question. The first thing you have to do is adjust the cost basis towards par ($1,000) in the amount of time the bond has until maturity. This customer purchased the bond at $900 (90), and it matures in 20 years.

20years

$900 → $1,000

The difference between the purchase price and par value is $100 ($1,000 - $900). Divide the difference by the number of years until maturity to get the annual accretion.

annual accretion = $100/20 years = $5

Next, take the $5 per year accretion and multiply it by the number of years the customer held the bond to get the total accretion.

$5 per year × 11 years = $55 total accretion

Now, take the $55 total accretion and add it to the purchase price of $900 to determine the customer's adjusted cost basis.

$900 original cost + $55 total accretion = $955 (adjusted cost basis)

For the final step, compare the $955 adjusted cost basis to the $920 (92) selling price to determine the amount of gain or loss.

$955 adjusted cost basis - $920 selling price = $35 capital loss