Question

Gordon enters into a Short Sale of Microsoft Stock on
3/31/20. Through his broker he borrows 10,000 shares of Microsoft stock. The stock that is
borrowed is from Karen. At the time that Gordon borrows the shares, Microsoft stock is
selling for $100 per share. Karen purchased the stock for $60 per share 2 years ago. Gordon
closes the short sale on 9/30/20 by returning the 10,000 shares of Microsoft to Karen’s
account. The Microsoft stock is worth $80 per share when it is returned to Karen. On
6/30/20, Microsoft paid a dividend of $1 per share. Gordon pays Karen $10,000 as a
substitute for the dividend.

(a) How much gain does Karen recognize when her shares are borrowed on 3/31/20?

(b) How much gain does Karen recognize when her share shares are replaced on 9/30/20?

(c) How does Karen treat the $10,000 substitute dividend payment on 6/30/20?

Answer 1

(A) Karen purchased the share for $60 and lended when the price was $100, hence she recognizes the gain of $40*10,000 shares = $400,000

(B) At the time of returning the price of share was $80, hence the net loss would be $100 - $80 = $20

Loss recognised = 10,000*20 = $200,000

Please note that the net gain recognised by Karen would be $400,000 - $200,000 = $200,000

(C) Dividend payment of $10,000 recieved will be recognised as dividend income by Karen.