CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA volume 2 finquiz item set questions, study session 4, reading 9

FinQuiz Item-set ID: 12499 Questions 112493 through 612498 relate to Reading 9 Heather Larson Case Scenario Heather Larson is a portfolio manager at Optimal Securities, an asset manage

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CFA Level III Item-set - Question

Study Session 4 June 2018

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FinQuiz Item-set ID: 12499

Questions 1(12493) through 6(12498) relate to Reading 9

Heather Larson Case Scenario

Heather Larson is a portfolio manager at Optimal Securities, an asset management firm Larson manages a $500,000 portfolio which includes a blend of equities and fixed income securities The expected return to be earned on the portfolio is 7.5% and the investment horizon is of 20 years The cost basis of the portfolio is equal to its market value Any ordinary income earned on Larson’s managed portfolio is subject to a progressive rate tax schedule, the details of which are illustrated below (exhibit 1) Larson expects to earn ordinary income of $65,000 on the portfolio

at the end of this year

Exhibit 1 Tax Structure on Ordinary Income Taxable

Income ($)

Tax on Column 1

Percentage on Excess Over Column 1

The tax rate on investment income is as follows:

Proportion of investment income = 20%; Taxes on interest income = 14%

Proportion of dividend income = 50%; Taxes on dividend income = 14%

Proportions of capital gains income 15%; Taxes on capital gains = 12%

Larson also manages a $200,000 portfolio that is purely invested in TDAs and TEAs The TDA account is invested in fixed income securities whereas the TEA account is invested in equities The pretax market values and weights of these accounts are highlighted below Withdrawals from the TDA account are taxed at a rate of 40%

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Exhibit 2 TDA and TEA Account Holdings

Value ($)

Pre-Tax Market Weights (%)

FinQuiz Question ID: 12500

1), the future value of Larson’s portfolio in twenty years time is closest to:

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TEA accounts, respectively are:

structure and taxes dividends and interest income at ordinary rates while taxes capital gains at favorable rates In this case, the tax regime within which Larson operates is a:

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Alan Smith Case Scenario

Alan Smith, CFA, works as an investment advisor at York Corporation, an investment banking firm in New York City Smith heads the tax advisory division at York Corporation Daniel

Anderson is an associate at York Corporation and reports directly to Smith Anderson has a new client Wesley Harris, who currently has $500,000 in a taxable investment account for which his main objective is retirement in 10 years time The gain in the client account will be composed of 10% interest, 30% dividends and 32% capital gains The expected tax rates on interest, dividends and capital gains are 30%, 20% and 10%, respectively The client’s portfolio is expected to have

a percentage cost basis of 75% Harris is concerned about the impacts of different types of taxes

on his portfolio While explaining the impacts of taxes on portfolio return, Anderson made the following statements:

Statement 1: “For accrual taxes which are paid periodically, the impact of returns on the tax

effect is greater for longer investment horizons, and the impact of investment horizon on the tax effect is greater for higher returns.”

Statement 2: “The proportion of investment growth consumed by wealth based taxes increases

as return increases.”

Anna and Watka Kristov are clients of York Corporation and take regular advice from Smith regarding tax status of their account The following data relates to Kristovs’ portfolio:

While explaining different taxation concepts relating to investment portfolios during a meeting with Smith and Kristovs, Anderson made the following statements:

Statement 1: “Tax savings realized in a given tax year from tax loss harvesting understate the

true gain.”

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realized taxes will be closest to:

income?

10 Which of the following most accurately characterizes the statements made by Anderson?

11 Which of the following is closest to the tax rate at which the portfolio will have an after-tax asset allocation of 63% bonds and 37% stocks?

12 With regard to his response to Anderson’s statements, Smith is least likely correct with respect to:

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Annabel Schultz Case Scenario

Annabel Schultz is a tax consultant serving an Australian tax advisory firm Her clients are primarily situated in Australia

Schultz is increasingly paying attention to the impact of taxes on investment portfolio

performance Shultz aims to achieve the following objectives with respect to her four clients’ portfolios:

Objective 1: Evaluate the impact of a tax loss harvesting strategy on Clint Jones’ portfolio Objective 2: Ascertain the after-tax asset allocation for Dina Lane’s A$5.0 million portfolio Objective 3: Compare the relative value accumulations in deferred capital gain and accrual

taxation environments with respect to Frieda Po’s portfolio

Objective 4: Compare the average and marginal tax rates of Kevin Russell’s portfolio

Jones’ portfolio was worth A$1,500,000 at the beginning of 2010 and generated capital gains following an increase in the value of the portfolio in the same year During the year, several portfolio securities experienced a cumulative capital loss which remains to be realized

Information and forecasted price change concerning these securities have been summarized by Shultz (Exhibit 1) The consultant advises Jones, “You should sell the loss securities today (2010) and reinvest the proceeds and tax savings in nearly identical securities”

The actual pre-tax asset allocation of Lane’s portfolio has been summarized by Schultz (Exhibit 2) Withdrawals from the tax deferred account (TDA) are made at a rate of 40%

Po’s A$250,000 portfolio is invested in three asset classes and is expected to generate an average expected annual return of 8% over fifteen years Po is Shultz’s sole foreign client The tax rate used for the analysis is 25% and the consultant would like to estimate the magnitude by which the amount accumulated in a deferred capital gain environment exceeds the amount accumulated

in an annual taxation environment Schultz makes the following comments with respect to the two tax environments:

Comment 1: In a deferred capital gains environment, tax drags increase with the passage of

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Russell has generated $150,000 taxable income in the current year The progressive tax rate schedule for the fiscal year, 2010, has been summarized by Schultz (Exhibit 3)

Exhibit 1 Information and Projection Concerning Jones’ Portfolio, as of 2010:

Portfolio’s percentage price increase, realized as capital gains

+ 25%

Securities with unrealized capital loss:

Current cost basis Current market value Forecasted percentage price change in 2011

A$100,000 A$70,000 + 30%

Exhibit 2 Pre-Tax Asset Allocation of Lane’s Portfolio

Existing Pre-tax Asset Allocation (%)

100

Exhibit 3 Progressive Tax Rate Schedule

A$37,000

A$80,000

A$180,000

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13 Using the information provided on Jones’ portfolio and Exhibit 1, the tax savings generated

by Schultz’s proposed strategy are closest to:

FinQuiz Question ID:19037

14 Which of the following limitation is most likely associated with the strategy recommended by Schultz for Jones’ portfolio?

15 Using the information provided with respect to Lane’s portfolio and Exhibit 2, the after-tax

asset allocation is most likely:

16 With respect to Po’s portfolio, the relative value of the accumulation calculated by Shultz is

closest to:

17 With respect to the comments made, Shultz is least likely correct with respect to:

18 Using the information in Exhibit 3, Russell’s marginal tax rate exceeds his average tax rate by:

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