Disposition of Fixedincome Securities
The sale or redemption of a fixedincome security by investors often results in a capital gain or a capital loss. For tax purposes, fixedincome securities encompass various instruments such as bonds, debentures, bills, notes, mortgages, hypothecs, and similar obligations.
Did You Know?
Not all fixedincome securities result in a capital gain upon disposition. For example, savings bonds typically lack a secondary market and hence do not fluctuate in price, eliminating the potential for capital gains.
Accrued Interest
Capital gains and losses on fixedincome securities are determined by subtracting the purchase cost from the sale proceeds (where purchase cost includes the adjusted cost base plus sales expenses). In addition, at the time of disposition, securities may have accrued interest that is owing. This accrued interest is not part of the capital gain calculation since it’s considered income for the seller. Purchasers can, therefore, deduct this from the interest they receive when declaring income on their tax return.
Example:
Scenario: Interest Accumulation
Imagine a situation where you sell a bond five months after the last periodic interest payment, and the next payment is due in one month. The buyer must pay you, the seller, for the accrued interest from the last payment date up to the settlement date.
Here’s a detailed calculation example:
Example Calculation
$$$$

Jared buys a $10,000 principal amount of a 5% semiannual bond at par. The bond pays interest semiannually.
Accrued Interest Calculation:
 Annual interest = 5% of $10,000 = $500
 Semiannual interest = $500 / 2 = $250
 Accrued interest for 5 months = \( \frac{250}{6} \times 5 \) (since each semiannual period has 6 months)
 Accrued interest for 5 months = \( \frac{250}{6} \times 5 = 208.33 \)
Conclusion
 Jared must pay the seller $208.33 in accrued interest.

Total acquisition cost for Jared:
 Principal: $10,000
 Accrued interest: $208.33
Final cost: $10,208.33
Explanation:
 Principal Amount: The face value of the bond Jared is purchasing.
 Accrued Interest: The interest owed to the seller for the period they held the bond from the last interest payment date to the date of sale. This is calculated based on the months passed within the semiannual period.
 Total Acquisition Cost: Sum of the bond’s principal value and the accrued interest, representing the total amount Jared has to pay to acquire the bond.
By breaking down the components and calculations involved, this example should now clearly illustrate how to determine the accrued interest and overall acquisition cost for a bond buyer.
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## What types of financial instruments are considered fixedincome securities for tax purposes?
 [ ] Only stocks and mutual funds
 [ ] Only savings bonds
 [x] Bonds, debentures, bills, notes, mortgages, hypothecs, and similar obligations
 [ ] Crypto assets
> **Explanation:** For tax purposes, fixedincome securities include bonds, debentures, bills, notes, mortgages, hypothecs, and similar obligations.
## Why do savings bonds typically not result in capital gains?
 [ ] They have very high returns
 [ ] Their prices fluctuate rapidly
 [x] They usually do not have a secondary market and therefore do not fluctuate in price
 [ ] They are exempt from capital gains tax
> **Explanation:** Savings bonds typically do not have a secondary market; therefore, they do not fluctuate in price and cannot generate a capital gain.
## How is the capital gain or loss on a fixedincome security calculated?
 [ ] By adding the initial investment amount to accrued interest
 [ ] By considering only the accrued interest
 [x] By subtracting the purchase costs (adjusted cost base plus expenses of the sale) from the proceeds of the sale
 [ ] By subtracting expenses of the sale from proceeds of accrued interest
> **Explanation:** Capital gains and losses on fixedincome securities are determined by subtracting purchase costs from the proceeds of the sale. Purchase costs consist of the adjusted cost base plus expenses of the sale.
## Why is accrued interest not included in the capital gains calculation?
 [ ] Because it is not a part of the total sale proceeds
 [ ] Because it is added to the capital gain
 [x] Because interest at the date of sale is considered income to the vendor
 [ ] Because it reduces the adjusted cost base
> **Explanation:** Accrued interest is not included in the capital gains calculation because interest at the date of sale is income to the vendor.
## In the event of selling a bond, when is the investor entitled to receive interest up to?
 [x] Up to the settlement date
 [ ] Up to the date of sale only
 [ ] Up to one month before the settlement date
 [ ] Immediately after the settlement date
> **Explanation:** Investors selling bonds are entitled to receive interest up to the settlement date.
## What must the buyer do if the date of sale is five months after the last regular interest payment and the next payment is due in one month?
 [ ] Pay the seller an additional premium
 [x] Pay the seller interest due from the last payment up to the settlement date
 [ ] Deduct accrued interest from purchase cost
 [ ] Ignore the accrued interest
> **Explanation:** The buyer must pay the seller interest due from the last regular interest payment up to the settlement date.
## How much did Jared pay for accrued interest when purchasing the $10,000 principal amount of a 5% semiannual bond?
 [x] $200
 [ ] $500
 [ ] $10,000
 [ ] $300
> **Explanation:** Jared paid $200 in accrued interest when purchasing the $10,000 principal amount of a 5% semiannual bond.
## If Jared buys a bond and pays accrued interest of $200 at the time of purchase, what is his total cost?
 [ ] $10,000
 [ ] $10,500
 [x] $10,200
 [ ] $10,300
> **Explanation:** Jared's total cost is $10,200, which includes the $10,000 principal amount and the $200 accrued interest.
## What does the seller of a bond include as investment income for the year of sale?
 [ ] Only the proceeds of disposition
 [x] The accrued interest received from the sale and any other interest received during the year
 [ ] Only other interest received during the year
 [ ] Only the purchase cost
> **Explanation:** The seller includes, as investment income for the year of sale, the accrued interest received from the sale and any other interest received during the year.
## When the buyer later sells the bond, what is considered the adjusted cost base?
 [ ] $10,200 (including accrued interest)
 [ ] $10,500
 [x] $10,000 (excluding accrued interest)
 [ ] $10,700
> **Explanation:** When the buyer later sells the bond, the adjusted cost base is $10,000, rather than $10,200, because the accrued interest paid to the seller is not included in the adjusted cost base.
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