Chapter 6 Practice Questions
1. Sally purchased an OID 20-year municipal bond for $4,000 five years after it was issued. The bond was issued at a price of $2,500. The par value of the bond was $10,000. Assuming she held the bond to maturity, and that this occurred before the ratable method was disallowed for calculating the accretion of OIDs, what was Sally’s taxable income?
A. $375 as ordinary income
B. $375 as capital gains
C. $0
D. $1,000 as capital gains
2. Lynn bought a 10-year municipal bond in the secondary market for $4,800. The bond has a face value of $5,000 with a coupon rate of 5%. It is redeemable in five years. She sells the bond two years later for $5,100. What are her capital gains or losses on the bond?
A. $220 capital gain
B. $300 capital gain
C. $200 capital loss
D. $100 capital gain
3. John recently sold a municipal bond. The proceeds from the sale were greater than the adjusted cost basis. Which of the following is true?
A. John has incurred capital gains that he must pay taxes on.
B. John has incurred capital gains that he will not pay taxes on, because municipal securities are tax-exempt.
C. John has not incurred capital gains, because this is not possible on municipal bond transactions.
D. John has incurred a capital loss that the he can use to offset other capital gains.
4. If a municipal OID bond is purchased at issue and is held to maturity, how will the appreciation on the value of the bond be taxed annually? Choose the best answer.
A. The bondholder will need to report the accreted interest on their taxes, but it will be tax-exempt
B. The bondholder will need to report the accreted interest on their tax forms and it will be taxed as ordinary income
C. The bondholder will need to report the accreted interest on their tax forms and it will be taxed as a capital gain
D. The bondholder will not need to report the accreted interest on their tax forms because it