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After last week's New Year's investing quiz, dozens of readers asked me to explain certain answers. The "rich uncle" question, in particular, had a lot of people scratching their heads.
If you haven't taken the quiz yet, you can take it online here.
I'll get to the rich uncle in a moment.
First, I'll explain a few other questions that stumped readers, starting with No. 12:
Justin buys 400 shares of XYZ Corp. at $20 a share. He sells 100 shares at $25 a share. He then buys 200 shares at $27 a share. Ignoring commissions, what is the adjusted cost base per share, for tax purposes, of his 500 shares?
a) $20.33
b) $21.80
c) $22.80
d) $22.33
Many readers picked b) $21.80, which was a trap. They arrived at this answer by taking the original cost of $8,000 (400 times $20), subtracting $2,500 (100 times $25), adding $5,400 (200 times $27) and then dividing the net result of $10,900 by 500 to get $21.80.
The problem here is that, when you sell part of your existing shares, the adjusted cost base (ACB) per share of your remaining shares doesn't change.
So, when Justin sells 100 shares at $25, his remaining 300 shares will still have an ACB of $20 a share. His total ACB adjusted cost base for those 300 shares would therefore be $6,000 (300 times $20). If he then buys another 200 shares at $27, the $5,400 cost would be added to $6,000, for a total ACB of $11,400.
Divide this by 500 to get the correct answer: c) $22.80.
Another question that gave some people trouble was No. 11:
On Dec. 31, company XYZ declared a quarterly dividend of $1, payable on Jan. 29 to shareholders of record on Jan. 12. To receive the dividend, the latest you could buy the shares would be:
a) Dec. 30
b) Dec. 31
c) Jan. 7
d) Jan. 11
When you purchase a stock, the trade settles three business days after the trade date. Because Jan. 9 and 10 fall on a weekend in 2016, you would have to purchase the shares no later than Jan. 7 in order to be a shareholder of record on Jan. 12. Correct answer: c) Jan. 7.
Next up, question No. 5:
Sophie is 43 years old and has made total TFSA contributions of $10,000. In 2015, she withdrew $7,000 to renovate her condo. As of Jan. 1, 2016, how much TFSA contribution room does she have?
a) $43,500
b) $5,500
c) $36,500
d) $46,500
To answer this question, you first need to know the total contribution room that has accumulated since the TFSA was launched in 2009. That amount is $46,500 ($5,000 for each of 2009 through 2012; $5,500 for 2013 and 2014; $10,000 for 2015; and $5,500 for 2016). You also need to know that, when a person makes a TFSA withdrawal, the amount is added back to his or her contribution room on Jan. 1 of the following year. Therefore, Sophie's contribution room is $46,500 minus the $10,000 she previously deposited, plus her $7,000 withdrawal, which is a) $43,500.
Now to No. 13, the rich uncle question. I adapted this from a classic math puzzle called the "Monty Hall Problem" (that version features three doors, behind one of which is a new car).
Your rich uncle holds up three envelopes. One contains $1,000; the others are empty. He asks you to pick an envelope. He then opens one of the other two envelopes, which is empty, and asks if you want to switch your choice. Should you?
a) No
b) Yes
c) It doesn't matter
d) Impossible to say
Many readers insisted that the correct answer is c) It doesn't matter. After all, if there are two envelopes remaining and one contains the $1,000, the odds of the money being in either envelope must be 1/2, right? Wrong. Back up for a moment. When you made your initial choice, your odds of guessing correctly were 1/3. The fact that your uncle then reveals an empty envelope (which he can always do because he knows where the cash is) doesn't retroactively make you a better guesser; the odds are still 1/3 that your original choice was correct. Therefore, the odds that the cash is in a different envelope are 2/3. With one of those envelopes eliminated, the odds are 2/3 that the cash is in the envelope your uncle still holds. So, switching will double your chance of getting the $1,000. It won't work every time, of course, but the probabilities favour switching.
John Heinzl