Possible error in exam on tax accretion

FINRA FINRA Series 7
1

Subject: Possible Error in Exam Question #20 – Tax Consequences from Accretion

Message:

Hi Achievable Team,

I came across a question on Exam #20 (screenshot attached) regarding the tax consequences of accreting a 10-year, $1,000 par, 11% mortgage bond purchased at 80 and sold at 98 after 8 years.

After breaking it down, the correct tax consequences should be:
• $160 of taxable interest (from accreting $20/year for 8 years)
• $20 of capital gain (sale at $980 with an adjusted basis of $960)

However, none of the provided answer choices reflect this correct combination. The closest options either underreport the taxable interest or incorrectly calculate the capital gain/loss.

Could you please review this question and confirm whether there’s a mistake in the answer choices?

@Justin

2

Hi, I reviewed this question, and it’s accurate.

Accretion relates to a bond discount, not a bond premium. When a bond discount is accreted, the investor adds the annualized discount to their taxable interest on an annual basis. This bond pays $110 in taxable interest annually and the annualized discount is $20 ($200 discount over 10 years). Therefore, the reported taxable interest this year is $130 ($110 coupon + $20 annualized discount).

After 8 years, the bond’s cost basis is $960 (cost basis rises by annualized discount every year). The bond’s sales proceeds is $980, which results in a $20 capital gain.

https://app.achievable.me/study/finra-series-7/quiz/3YM7K#seed=DMXCR&slug=an-investor-purchases-a-10-year-dollar1000-par-11percent-mortg…

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