Test Traps: What’s the Dividend Record Date for a Cash Settlement?

See below for a transcript of the video.

Sample Question: Cola Co. stock is traded on the New York Stock Exchange. Its board of directors has recently declared a dividend and set a record date of Monday, May 24. In order to receive the dividend in a cash settled transaction, an investor must purchase the stock no later than:

A. Wednesday, May 19

B. Thursday, May 20

C. Friday, May 21

D. Monday, May 24

Trap 1: The important part of the question is at the end

Let’s look at trap number one. On the exam, you may see a beautiful answer to a different question somewhere in A, B, C, and then buried is the very best answer down at the bottom, D. And that’s what you have here.

The real meat of this question starts with the last sentence, and that’s often the case. Sometimes if you have a lengthy question, it just goes on and on, and it throws all kinds of detail at you, and you’re thinking what’s important and what’s not.

Start by reading that very last question with the question mark.

Once you know where you’re going, then you can start at the top and sit down through all that information that you don’t need, and write down the two or three facts that you do need on a piece of scratch paper. And by the way, scratch paper and a pen are your friends.

Get in the habit of diagramming.

It’s often easier to work from your own diagram on your scratch paper than it is staring at that computer screen with a bunch of information that you don’t need distracting you from the relevant facts.

So if we look at this question right here, look at the last sentence, that’s the meat of the question. “In order to receive the dividend in a cash settled transaction, an investor must purchase the stock no later than…” Let’s take a deep breath, and let’s think about what we already know here.

What happens on a trade date versus a settlement date?

On a trade date, two broker dealers come together and they agree to the terms of a trade. In other words, they agree to trade 500 shares of Google at 103 and a half, or they agreed to trade 100 shares of Facebook at 94 and 78. That’s what happens on the trade date. The two parties come together and they set a time and a price, and a quantity and then they scatter; that’s a trade date.

On a settlement date, the two broker dealers meet, and one hands over cash and the other hands over the security. So on a trade date, the terms are set. On a settlement date, the terms of the trade are performed, cash and securities trade hands. Now, remind yourself of what you’ve known your entire life. When you hand over cash for something, and you collect that gizmo. that’s when you become the owner of that gizmo, right? Whether it’s a Toyota pickup truck or a grapefruit or a municipal bond or shares of stock. When the cash gets handed over and the securities change hands, that’s when the buyer becomes the owner on a settlement date. You’ve known that your entire life, we’re just applying simple concepts to the securities world now.

When does the trade date equal the settlement date?

So back to this question right here, “in order to receive the dividend in a cash settled transaction.” This is a cash settled transaction so, remember what that means. In a cash trade, a trade that settles in cash, trade date equals settlement date, right? Trade date equals settlement date for a trade that settles in cash.

Trap 2: You fail to answer the question being asked

Now, look at this test question. It had us charge down the road thinking, oh, regular way settlement, plus two. I’ve got to find the record date. I’ve got to back it up to a business day, and that would have been answer C, wouldn’t it? And normally, that’s the way this question is asked in terms of regular ways settlement. Not so on this one: the trade curve here was the trade date. So, how many times, is this already happening? You put down a magnificent answer to a different test question, right? Happens to me all the time, even now when I’m tired.

Make sure you answer the question that they ask you. Read carefully. And really, this can be summed up in the last sentence. In a cash trade, the investor has to buy no later than the record date. And what happens to be the record date? Well, they told us it’s Monday the 24th. You’ve seen that trap; you’re not going to fall into that next time.