Explanation Taxes lower returns, but they also shift some of the investment risk to the government.. Among global tax regimes, the common progressive tax regime has a favorable tax treat
Trang 1Test ID: 7426238 Taxes and Private Wealth Management in a Global Context
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On a graph where the risk is on the horizontal axis and the returns are on the vertical axis, the existence of taxes on
investment returns would probably shift the mean-variance optimization portfolio:
down and to the left
down only, and there would not be a shift left or right
down and to the right
Explanation
Taxes lower returns, but they also shift some of the investment risk to the government
An investor deposited $33,000 in a zero coupon bond position 20 years ago It consisted of 100 zero coupon bonds each with
a face value of $1,000 and 20 years to maturity The investor's current marginal tax rate is 30% At maturity, and after all taxes have been paid, the value of the position is $84,500 Compute the accrual equivalent after-tax return
4.81%
3.99%
4.33%
Explanation
The accrual equivalent after-tax return = 4.81% = ($84,500 / $33,000) − 1 The current marginal tax rate is not relevant to solving the problem
Among global tax regimes, the common progressive tax regime has a favorable tax treatment for:
interest income and dividend income but not capital gain income
dividend income and capital gain income but not interest income
interest income, dividend income, and capital gain income
Explanation
The common progressive tax regime tends to have a favorable tax treatment for all three
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Which of the following has favorable tax treatment under a "flat and heavy" tax regime?
Interest income
Capital gains
Dividend income
Explanation
The tax on ordinary income is flat and there is not a favorable tax treatment for dividend income and capital gain income Interest income has a favorable treatment
The nation of Pensacola is best described as having a flat and heavy tax regime Which of the following assets would be most appropriate for Pensacola investors using a TDA?
Interest bearing, taxable bonds
High dividend yielding stocks
Tax-exempt bonds
Explanation
In a Flat and Heavy Tax Regime, interest income receives favorable tax treatment but dividends do not The high dividend yielding stocks are therefore most appropriate for a TDA Tax-exempt bonds don't require the tax protection provided by a TDA
A stock is expected to increase in value from $500 to $1,000 over a five-year period The applicable capital gains tax rate is 28% What is the expected after-tax value in five years?
$781
$860
$552
Explanation
The pre-tax investment return is 14.87% =($1,000/$500) - 1
The formula for the future-value interest rate factor is FVIF = [(1 + R) (1 - T ) + T ]
1.72 = [(1.1487) (1 - 0.28) + 0.28] Thus, the after-tax value in five years is expected to be $860 = $500 × 1.72
Assume that €125,000 is invested in a tax-exempt account What is the after-tax balance in the account after 15 years if the tax rate is 28% and the pre-tax return is 11%?
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€598,074
465,613
392,138
Explanation
The balance in the account in 15 years uses the future value interest factor for a tax-exempt account (FVIF ) No taxes are due on the future accumulation
FVIF = (1 + R)
FV = 125,000[FVIF ]
FV = 125,000[(1.11) ]
FV = 598,074
The response of €392,138 is the future accumulation for an account taxed annually The response of €465,613 is the future accumulation for an account with tax deferred capital gains and a basis of €125,000
The tax rate is 34% An investment of $5,000 earns a pre-tax return equal to 8%, which is taxable each year What will the investment be worth in ten years after taxes?
$8,364
$7,124
$8,056
Explanation
After-tax value = $5,000 × [1 + 0.08 × (1 − 0.34)] = $8,364.28
In a tax-exempt account, contributions to the account are made with:
after-tax funds and reduce the investor's current tax bill
after-tax funds and do not reduce the investor's current tax bill
pre-tax funds and reduce the investor's current tax bill
Explanation
The tax benefit for a tax-exempt account occurs when the funds are withdrawn
An investor deposited $54,000 in a zero coupon bond position 10 years ago It consisted of 100 zero coupon bonds each with
a face value of $1,000 and 10 years to maturity The investor's average marginal tax rate is currently 20% At maturity after all taxes have been paid, the value of the position is $92,000 Compute the accrual equivalent tax rate
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16.27%
12.18%
14.00%
Explanation
The accrual equivalent after-tax return = 5.47% = ($92,000 / $54,000) − 1
The pre-tax return would have been 6.36% = ($100,000 / $54,000) − 1
The accrual equivalent tax rate is then 14% = 1 − (5.47% / 6.36%)
With respect to active investors and the tax structure in many countries, which of the following is the most accurate?
To offset their higher taxation, active investment managers must use
tax-exempt accounts
As a result of their lower taxation, active investment managers can remain in business
even when they generate lower pre-tax returns
To offset their higher taxation, active investment managers must generate higher
pre-tax returns
Explanation
To offset their higher taxation, active investment managers must generate higher pre-tax returns This is also true for mutual funds, especially those with high turnover, because in many countries, long-term capital gains are taxed at a lower rate and accumulate tax-free until the gains are realized
When highest-in-first-out (HIFO) accounting is allowed, it is advisable for:
an investor to liquidate the portion of a position with the lowest cost basis
first, thereby minimizing current taxes
an investor to liquidate the portion of a position with the highest cost basis first,
thereby minimizing future taxes
an investor to liquidate the portion of a position with the highest cost basis first,
thereby minimizing current taxes
Explanation
If an investor has accumulated a security position through a series of trades each occurring at different points in time and at different prices and if HIFO accounting is allowed by the government, the investor can liquidate the portion of a position with the highest cost basis first This minimizes current taxes As with tax loss harvesting, the total taxes over time are unchanged with HIFO accounting
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Trang 5Question #13 of 37 Question ID: 465043
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Of traders, active investors, and passive investors, which probably forgo the most tax advantages of equity?
Traders
Passive investors
Active investors
Explanation
Traders trade the most frequently, and would forgo the tax-deferred properties of equity that is allowed to grow in value over a long period Active investors trade less frequently than traders
Which type of equity investor recognizes all gains in the short term?
Exempt investors
Active investors
Traders
Explanation
Traders forgo the tax advantages associated with equity, and therefore all gains are recognized in the short and term and taxed on an annual basis Active investors trade less frequently than traders, so they recognize gains in the long term and are taxed at lower rates Exempt investors avoid taxation altogether and hold all of their stock so no gains are recognized
If an investment is held in an account that is taxed annually, the government bears:
some of the investment risk
all of the investment risk
none of the investment risk
Explanation
If the investment returns are taxed solely as income at the tax rate t and the pre-tax standard deviation of returns is S, then the investor's after-tax risk is S × (1 − t), and the government bears a portion of the risk
An investor faces the periodic payment of investment income taxes With respect to the relationship between investment horizon and investment return, the tax drag is:
positively related to the horizon and negatively related to the investment
return
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positively related to both the horizon and investment return
negatively related to both the horizon and investment return
Explanation
Both a longer horizon and a higher return will increase the tax drag
Chris Manning, CFA is advising a client concerning harvesting tax losses The client expects that her tax situation will not change over the next few years She asks about incurring a given loss in the current year or waiting a few years to incur the loss She asks how the decision will affect the total taxes she pays over her life Manning should advise her that:
she should not incur the loss this year because the HIFO principle means her
total taxes will be higher if she incurs the loss this year
she should incur the loss this year because the HIFO principle means her total taxes
will be lower if she does
the total tax bill over her life will not change if her tax status does not change
Explanation
Under the indicated conditions, i.e., the tax rate not changing in the foreseeable future, the total tax burden will be the same It
is better to take losses early only to reap the gains earlier and be able to invest the gains earlier
In applying efficient frontier analysis for an investor who uses both taxable and tax-advantaged accounts, the mean-variance optimization:
cannot simultaneously determine both the weights in the available assets and
their location in the various accounts, but it can be done in a step-wise
fashion Usually the weights are determined first and then the locations
cannot simultaneously determine both the weights in the available assets and their
location in the various accounts, but it can be done in a step-wise fashion Usually the
locations are determined first and then the weights
would simultaneously determine both the weights in the available assets and their
location in the various accounts
Explanation
The mean-variance optimization should optimally allocate assets and determine the optimal asset location for each asset Substitution of adjusted returns would allow the process to be done in one step
An individual, aged 40, is currently in the 25% marginal tax bracket, and expects to be in the 15% bracket when he retires
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Making contributions today to a tax-deductible individual retirement account is an example of:
deferring the timing of the tax payment
both minimizing the amount and deferring the timing of the tax payment
minimizing the amount of the tax payment
Explanation
The investor's action is an example of both minimizing and deferring He will minimize taxes by converting income that would have been taxed at a 25% rate today to a lower 15% rate in the future He will defer taxes payable until the funds are
withdrawn from the account in the future
Gil Tabor, CFA, and Jan Sills, CFA, are discussing how the choice of account type affects investment risk and the amount of that risk borne by the government via taxes Tabor says that the government bears some of the tax risk in a tax-exempt account Sills says the government bears some of the risk in a tax-deferred account before withdrawals occur With respect to these assertions:
both Tabor and Sills are correct
both Tabor and Sills are incorrect
Tabor is correct and Sills is incorrect
Explanation
If the investment is held in a exempt account, then the investor bears all the investment risk This is also true for tax-deferred accounts before withdrawals occur because even though the government taxes the future accumulation, the
variability of returns during the deferral period is not reduced by taxes levied at the time of withdrawal
Which of the following moves by a government would most likely lead to the government taking on more investment risk?
Moving from a common progressive tax regime to a heavy dividend tax regime
Moving from a heavy dividend tax regime to a common progressive tax regime
Tax regimes cannot shift investment risk
Explanation
Moving from a common progressive tax regime to a heavy dividend tax regime would increase the tax on dividends, which are taxed annually, and this would shift some of the investment risk to the government
With respect to the "heavy dividend" tax regime and the "heavy interest" tax regime, which if either usually has a progressive ordinary income tax structure?
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The heavy dividend tax regime only
Both
The heavy interest tax regime only
Explanation
Both have progressive tax structures for ordinary income They differ on having a less favorable tax structure for the indicated source of income
With respect to traders and active investors, which of the following statements is the most accurate?
Active investors trade as frequently as traders but they use strategies that lead
to their gains being taxed at higher rates
Active investors trade less frequently than traders so that many of their gains are
taxed at lower rates
Active investors trade more frequently than traders so that many of their gains are
taxed at lower rates
Explanation
Traders trade more frequently Therefore, traders generally pay higher tax rates
The main benefit of tax-loss harvesting is:
saving on current taxes
saving on future taxes
reducing both current and future taxes
Explanation
Although tax loss harvesting saves on current taxes, the apparent tax savings in a given year are misleading This is because when the security is sold and the proceeds are reinvested, the cost basis of the new, replacement security is the low sales price of the old security In other words, when the old security is sold, the cost basis for future taxes is reduced, thereby resulting in higher taxes in the future
If an investment is held in a tax-exempt account, then the investor bears:
all of the investment risk
some of the investment risk
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none of the investment risk
Explanation
In a taxable account, losses realized result in a reduction in taxes that serve to offset the magnitude of the loss Thus, some of the downside risk is transferred to the government In a tax-exempt account, the variability of returns is not affected by the taxes
Given an accrual equivalent after-tax return equal 6% and a pre-tax return equal to 7.2%, what is the accrual equivalent tax rate?
20.00%
12.93%
16.67%
Explanation
The accrual equivalent after-tax rate is:
0.1667 = 16.67% = 1 − (6% / 7.2%)
Assume that €125,000 is invested in a TDA What is the after-tax balance in the account after 15 years if the tax rate is 28% and the pre-tax return is 11%?
€430,613
598,074
392,138
Explanation
The balance in the account after payment of taxes in 15 years uses the future value interest factor for a TDA (FVIF ): FVIF = (1 + R) (1 − T )
FV = 125,000[FVIF ]
FV = 125,000[(1.11) (1 − 0.28)
FV = 430,613
Sam Conner and Bill Pope live in different countries In Conner's country, there is a light capital gain tax regime In Pope's country there is a heavy capital gain tax regime They both are building diversified portfolios that hold non-dividend-paying growth stocks, dividend-paying stocks, and coupon-paying bonds They both have a buy-and-hold strategy Which, if either, would probably benefit the most from a tax-deferred account (TDA)?
TDA
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Pope would benefit more than Conner
Conner would benefit more than Pope
Neither would benefit because tax-deferred accounts do little to enhance the returns
of diversified portfolios
Explanation
Conner would benefit more In a light capital gain tax regime, dividends and interest do not receive favorable tax-treatment There would be an advantage to having them in the TDA In the heavy capital gain tax regime, interest and dividends receive tax advantages
You compute that an investment with a current value and basis equal to $20,000 will have an annual pre-tax return equal to 10% for the next 12 years until it is sold The effective capital gains rate will be 15% What will be the accrual equivalent after-tax return?
9.02%
12.50%
8.50%
Explanation
The balance in the account after payment of all taxes in 12 years uses the future value interest factor after all taxes:
Future value = $20,000 × [((1.1) ) × (1 − 0.15) + 0.15] = $56,353
The accrual equivalent after-tax return is then ($56,353 / $20,000) − 1 = 9.02%
An investor holds the same investment in three different accounts Which of the following accounts will have the lowest risk?
A tax-exempt account
A taxable account
A TDA
Explanation
The taxable account will have the lowest risk because the government essentially shares the risk of the investment with the investor when it is taxed annually When taxed annually, the standard deviation of the investment returns is reduced by (1- T )
In applying efficient frontier analysis for an investor who uses both taxable and tax-advantaged accounts,
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