# Gotcha! Spotting the traps in last week’s quiz

Thanks

to everyone who took Investor Clinic’s seventh annual back-to-school investing and money quiz. If you missed last week’s quiz, you can still take it (tgam.ca/quiz17).

As promised, today I’ll explain some of the more challenging questions. Based on the feedback I received from readers, some of the traps I laid were extremely effective. Let’s start with question No. 6, which prompted the most e-mails from readers, some of whom insisted that my answer was wrong. Dave holds 100 shares of Johnson & Johnson in his TFSA. If J&J declares a quarterly dividend of 84 cents (U.S.), how much will Dave receive if his broker converts U.S. cash at an exchange rate of 80 cents (U.S.) for every $1 (Canadian)? a) $67.20 (Canadian) b) $89.25 (Canadian) c) $98.55 (Canadian)

d) $105 (Canadian) Many readers chose d) $105, which is incorrect. They multiplied J&J’s dividend of 84 cents (U.S.) by 100 shares, then divided the product of $84 by the Canadian dollar’s value of 80 cents to get $105 (Canadian). And that would be correct, except for one thing: In a tax-free savings account, U.S. dividends are subject to a 15-per-cent U.S. withholding tax. Dave would therefore receive $71.40 (U.S.) – i.e., 85 per cent of $84 – which works out to answer b) $89.25 (Canadian).

Keep in mind that U.S. withholding tax also applies to registered education savings plans, as well as to non-registered accounts. The only way to avoid withholding tax is to hold your U.S. dividend stocks in a registered account that is specifically for retirement purposes, such as an RRSP, RRIF or LIRA. These accounts are exempt from withholding tax under the U.S.-Canada tax treaty. Several readers were also tripped up by question No. 12: On Aug. 23, Royal Bank of Canada raised its quarterly dividend by 4 cents to 91 cents a share, payable on Nov. 24 to shareholders of record on Oct. 26. To receive the dividend, an investor would need to buy the shares: a) On or before Nov. 21 b) On or before Oct 25 c) On or before Oct. 24 d) On or before Oct. 23 To get the correct answer, you would need to know about a recent change in the settlement period for stock trades. Previously, trades settled – that is, shares and cash actually changed hands – three days after the trade date. This was known as “T+3”. As of Sept. 5, however, the settlement period was shortened to two days, or “T+2”.

As a result, one would need to buy the shares on Oct. 24 or earlier in order to be a shareholder of record on Oct. 26 and receive the dividend. So the correct answer is c. Another question that had some readers scratching their heads was No. 4: In a non-registered account, Gladys buys 100 shares of Bank of Montreal at $55 and 200 shares at $70. She then sells 200 shares at $80 (and pays the capital gains tax). If she later contributes the remaining 100 shares to her tax-free savings account when the price is $90, she would report a capital gain of: a) $2,500 b) $3,500 c) $5,500 d) zero The first step is to calculate the cost of the 300 BMO shares Gladys buys. That’s easy: $19,500 ($5,500 plus $14,000). Her cost per share is therefore $65 ($19,500/300). Now, the key thing to understand is that when Gladys sells 200 shares at $80 each, her cost per share for the remaining 100 shares doesn’t change – it’s still $65 a share. Transferring those 100 shares in-kind to a TFSA is known as a deemed disposition and the tax consequences are the same as if she had sold the shares. Her capital gain would therefore be the $9,000 value of the shares at the time of disposition minus their cost of $6,500 ($65 times 100), which gives us answer a) $2,500. Question No. 3 stumped a few people, but the explanation is relatively straightforward: Company XYZ trades at a priceto-earnings (P/E) multiple of 17. Its earnings yield is: a) 8.5 per cent b) 6.5 per cent c) 5.9 per cent d) unknown The price-to-earnings (P/E) multiple is the share price divided by the earnings per share over a 12month period. A P/E of 17 means an investor has to pay $17 for every $1 of earnings. The earnings yield is the reciprocal of the P/E: If you get $1 in earnings from a stock that costs $17, the yield is $1/$17 or about 5.9 per cent, which is answer c. Finally, we’ll look at question No. 14. In a non-registered account, Sandra buys 100 shares of Procter & Gamble at $71 (U.S.) when the Canadian dollar is trading at 90 cents (U.S). She later sells the shares for $88 (U.S.) when the loonie is at 75 cents (U.S.). Her capital gain is: a) $1,888.89 (Canadian) b) $2,060.61 (Canadian) c) $2,266.67 (Canadian) d) $3,844.44 (Canadian) To determine the capital gain (or loss) on a foreign stock, you must calculate the cost in Canadian dollars using the exchange rate that was in effect on the purchase date. You would then subtract the cost from the proceeds, also in Canadian dollars, using the exchange rate in effect on the sale date. In the example, the cost was $7,100 (U.S.)/$0.90 (U.S.), or $7,888.89 (Canadian). The proceeds were $8,800 (U.S.)/ $0.75 (U.S.), or $11,733.33 (Canadian). The capital gain is therefore $11,733.33 minus $7,888.89, which is d) $3,844.44.