Embedded Tax Liabilities & Portfolio Choice


 Georgia Davidson
 2 years ago
 Views:
Transcription
1 Embedded Tax Liabilities & Portfolio Choice Phillip Turvey, Anup Basu and Peter Verhoeven This study presents an improved method of dealing with embedded tax liabilities in portfolio choice. We argue that using a riskfree discount rate is appropriate for calculating the present value of future tax liabilities. Supportive of recent research, our results found a taxationinduced preference of holding equities over bonds, and a location preference of holding equities in the taxable account and bonds in retirement accounts. These important findings contrast with traditional investment advice which suggests a greater capacity for risk in retirement accounts. While taxes are only one factor in portfolio selection and evaluation, it is an important factor. Recent research deals with the issues of tax efficiency of different asset classes as well as their location preferences between available savings vehicles due to differential tax treatments. However, with multiple tax environments and deferred capital gains, the effect can be complex so how investment portfolio decisions should incorporate taxes is not always obvious. Nevertheless, practitioners need to identify and address these complexities in order to devise an optimal investment program for their clients. While there are numerous papers in the area of aftertax investing i, one area where the literature has not made much headway is how to deal with embedded capital gains and implied deferred tax liabilities. ii One approach treats embedded capital gain taxes as a transaction cost in the portfolio optimisation process (Arnott, Berkin, & Ye, 2000). While this approach shows that investors should avoid turning over assets with embedded capital gains, it does little for evaluating the aftertax value or aftertax return of the asset. Phillip Turvey is a PhD candidate in finance, Anup Basu is a senior lecturer and Peter Verhoeven is an associate professor. All authors are from School of Economics and Finance at Queensland University of Technology, Australia. 1 Electronic copy available at:
2 Reichenstein (2006, 2007a, 2007b, 2008a, 2008b) shows that $0.70 in a Tax Deferred Account (TDA) is equivalent to $1 in a Roth account and recommends adjusting effective asset allocations to reflect this fact. He also suggests adjusting the taxable account for the value of any embedded tax liability as if it were sold today, but this overlooks the time value of money the asset may not need to be sold today, but at some uncertain time in the future. Because a dollar tomorrow is worth less than a dollar today, the principal values need to be adjusted for the present value of the implied capital gains tax. Indeed, Horan and Al Zaman (2008) [H&A hereafter] use this present value approach within a meanvariance optimisation framework. They argue that when a capital gains tax is delayed, more wealth can remain invested in the asset, and conclude that the aftertax return on the asset is the correct discount rate to use. Other authors like Berkin and Luck (2010) make similar arguments. This line of reasoning has intuitive appeal but, as we show in his paper, it does not properly consider the increase in risk to an investor s aftertax wealth. In this article, we propose a number of improvements to the H&A model most importantly the way in which embedded capital gains are valued. Embedded capital gains represent an implicit future tax liability and can be considered an interestfree loan from the government. While the H&A model attempts to value this future tax liability using an equity rate of return, we show that using an aftertax riskfree discount rate is more appropriate as it accounts for the change in risk to the investor s aftertax wealth. This suggests that embedded tax liabilities have a greater impact on asset allocation than assumed by the current literature and they dramatically increase preference for holding equities in taxable accounts and bonds in retirement accounts. These results are contrary to traditional investment planning advice, which generally views retirement accounts as more suited to taking on risk due to their long investment horizon. The most likely explanation for these results is the preferential taxation treatment of equities compared to bonds. iii 2 Electronic copy available at:
3 Current Treatment of Taxes in the Literature Adjusting returns for immediate taxation and where tax credits are given on losses is straightforward. Aftertax investment returns ( ) are calculated as the pretax return ( ) multiplied by one less the applicable tax rate ( ): 1 (1) The adjustment to an asset s risk (or standard deviation) for taxes is less obvious than the method for adjusting returns. Say that the pretax return of an investment is 20% in a good year and 0% in a bad year (i.e. 10% ± 10%). Also, assume a tax rate of 30% and that tax credits are given for any losses generated. Substituting these numbers into equation (1), a good year will produce an aftertax return of 14%, while a bad year will produce an aftertax return of 0%. The expected taxadjusted return is therefore 7% ± 7%. Effectively, the government shares both risk and return with the investor such that the risk to the investor drops proportionally with aftertax returns. That is, if the aftertax return drops by 30% compared to the pretax returns, the standard deviation will also reduce by 30%. As the government is risksharing in gains and losses, the aftertax standard deviation ( ) of an asset s return also reduces by (1 ): 1 (2) However, what adds complexity to the issue is that taxes on capital gains are only payable when they are realised. This leaves us with two problems: (i) how do we value the future tax payable on an unrealised capital gain?; And (ii) how does this affect effective annual returns for assets that generate capital gains? The H&A paper presents a taxadjusted optimisation model in the presence of multiple taxation environments based on the work of Wilcox, Horvitz and dibartolomeo (2006). In their world, there are three tax environments (i) the normal taxable account iv with various marginal tax rates; (ii) the aptly named Tax Deferred Account (TDA) where 3 Electronic copy available at:
4 withdrawals are taxed at a flat rate of 30%; and (iii) the taxfree Roth account. v Proportions invested in each location are fixed and cannot be reallocated. There are two assets equities and bonds and investments can flow into them through any of the three accounts. For the taxable account, returns from investments can be broken up into ordinary income, dividend income, immediate capital gains, and deferred capital gains each attracting their own tax rates. When these assets are invested through the different tax environments, they are treated as distinct investment opportunities because the aftertax cash flows associated with each asset are different. H&A offer two separate approaches to dealing with deferred tax liabilities one using a pretax principal value and the other using a posttax principal value. Both approaches first calculate what the value of the taxable account will grow to by the end of the investment period after all taxes, including final capital gains tax, are considered. The pretax principal method then calculates an effective compounding rate for the annual return to achieve the same terminal value. In contrast, the posttax principal value determines what the aftertax return should be and discounts the expected future value using this discount rate to determine the asset s posttax principal value. Due to the problems associated with their pretax principal method mainly due to the fact the tax adjustments can yield negative asset returns we focus on their posttax principal method. The investor s expected terminal wealth value of the taxable account ( ) is based on the present value of taxable account ( ), expected returns less immediate taxes ( 1 ) compounded for the investment time horizon ( ), and adjusted for the tax on final capital gains: (3) where = initial cost basis on the investment 4
5 = tax rate on deferred capital gains = effective annualised tax rate for deferred capital gains The adjustment is important because the components of return that are taxed along the way and reinvested are not taxed again as a capital gain. It is calculated as: where 1 (4) = proportion of the returns that represent deferred capital gains = effective tax rate on gross income that accounts for all immediate sources of taxation. H&A specifies as a function of the proportion of income that are ordinary income ( ), dividend income ( ), immediate capital gains ( ), and their respective tax rates (,, ): (5) Because an unpaid tax liability can remain invested, the authors conclude that the appropriate discount rate should reflect the aftertax cost of equity for that asset. They approximate this by making adjustments to the standard CAPM as follows vi : where 1 (6) = market risk of the asset = expected return on the market portfolio = riskfree rate Using this discount rate, along with the expected future value already calculated in equation (3), they calculate the aftertax present value of an asset in the taxable account ( ) as follows: 5
6 1 P (7) From the above it is clear that they effectively adjust the principal value for all current and future expected capital gains taxes. For the TDA, the investor must pay a 30% withdrawal tax on the gross amount and is essentially a caretaker of this money, with the government taking on all the risk associated with this 30%. As such, the principal value of the TDA needs only be lowered by a flat 30% to make it effectively taxfree. The Roth account being untaxed requires no adjustments. The investor s total posttax wealth is simply the sum of these aftertax values, while the posttax weights are measured as the account s posttax values divided by the investor s total post tax wealth. As it is assumed that the government equally shares in both gains and losses, taxes have no impact on the correlations between the assets. vii Nevertheless, the covariance terms do become smaller since the average deviation from the mean will be less as a result of this risksharing. H&A generate formulas for the aftertax covariances between the different asset classes and locations. Their adjusted equations for standard deviation and covariance are as follows: and where cases. viii 1, (8), 1, 1, (9), = effective tax rates on gross returns for immediate income for assets i. Note that for the Roth account and TDA are zero, so these terms drop out in some 6
7 Improved Method for Considering Taxes When looking back at equations (6) and (7) above, one question that may crop up is why combine a pretax riskfree rate with an aftertax risk premium? H&A (2008, pp ) argue that the government is a silent risksharing partner (we agree) and conclude that this only relates to the risk premium (we disagree). They argue that this risksharing does not extend to returns on the riskfree rate, because it by definition has no risk and the government cannot share in something that does not exist. However, it is not difficult to recognize that the government shares in riskfree returns regardless of the lack of risk. For example, the government still manages to tax interest on government bonds despite its essentially riskless nature. This renders the H&A discount rate inherently flawed (Reichenstein, 2007c). ix Simply correcting the above flaw, however, would not account for the change in risk to the investor s equity. To illustrate this changing nature of the risk, consider the following example. An investor has a $100,000 asset with an embedded tax liability that has a present value of $10,000 leaving the investor with true wealth of $90,000. Using H&A s method, we are lead to believe that his aftertax allocation is $90,000 and that $100,000 with embedded capital gains is equivalent to owning a $90,000 asset without embedded gains. However, the investor still has $100,000 exposure to shares so that if the underlying asset increases by 10%, the investor s asset will grow by $10,000, not $9,000. This means that 111% of the investor s true wealth is invested in shares and 11% is invested in cash as a $10,000 loan from the government which is effectively a leveraged investment. In order to maintain the investor s desired asset allocation of say 100% equity, he would need to reallocate 11% of his wealth (or $10,000) to the riskfree asset to meet the future tax liability when it falls due. The amount invested would grow at the riskfree rate less tax on ordinary income, compounding yearly (n). That is, it would grow by 1 1. This method 7
8 of investing the present value of the embedded tax liability into the riskfree asset maintains a constant risk level for the investor. Hence, using the aftertax riskfree rate is the most appropriate rate for calculating the present value of tax liabilities. The present value of the tax liability is therefore calculated as: where = deferred capital gain = tax on those gains 1 1 (10) There are other ways to calculate the present value of the tax liability including: (i) an amortisation approach where the liability is paid gradually; and (ii) a reducing balance approach, e.g. 20% of the embedded liability is triggered each year. Alternatively, there could be a combination of these methods. The method chosen may depend on the type of investment. For example, a company stock directly owned by the investor is likely to only have a capital gains tax (CGT) event at sale, while an indirectly owned managed fund may regularly generate CGT events due to normal fund turnover. However, the aftertax riskfree rate remains the appropriate discount rate to use. Equation (10) leads us to the new equation for the aftertax present value of the taxable account ( ): (11) Although equation (11) calculates the aftertax value of the taxable account, it does not consider the implicit leveraging effect within the taxable account. Hence, further examination is required. The H&A approach deducts the tax liability from equity and bonds on a prorated basis for all accounts. Instead of adjusting the bond and equity assets equally for the tax liability, we propose deducting the present value of the tax liability from the riskfree 8
9 allocation to reflect the effective interest free loan from the government. In our proposed method, the posttax principal value of the equity allocation is unaffected by the future tax liability and,,. x The present value of the future tax liability is instead deducted from the allocation to the riskfree asset, such that:,. (12) These proposed changes will correctly adjust for the change in risk to the investor s wealth and are able to incorporate the implicit leveraging effect. If preferred, the present value of the tax liability could be deducted from the bond allocation, but in this case the present value calculation should use the return on those bonds as well. The investor should use whichever method best reflects their investment opportunities. Importantly, while the H&A method incorporates the existing and future capital gains into their present value calculations, our method adjusts present values only for existing capital gains. To achieve this, our model incorporates the present value of any new (or reduced) capital gains tax generated in any period as part of that period s return. Intuitively this makes more sense since the increase or decrease in the embedded tax liability is in fact a component of that asset s investment returns. To accomplish this, we rewrite equation (1) incorporating the present value of any new embedded liabilities created or lost during the period. The formula becomes: 1 t (13) 1 1 where = proportion of the pretax returns that are deferred capital gains That is, the aftertax return is equal to pretax returns ( ) multiplied by 1 less the tax rate on gross returns for all immediate sources of income ( ), less the present value of the 9
10 future tax liability. Here, n refers to the investment horizon, (n1) reflects how long the capital gains tax is deferred compared to taxes on dividends, and is the tax on deferred capital gains. Taxes on dividends are assumed to occur at the end of the year in which they are received. With respect to capital gains tax, if this same logic is followed, the tax would occur at the end of the nth year i.e. (n 1) years after the tax on dividends is due. xi The adjustment to aftertax standard deviation is proportional to aftertax returns, which yields: 1 t. (14) 1 1 For covariance calculations with embedded taxes all that is required is to use the aftertax standard deviation of each asset and substitute these into the equation for calculating the covariances. The covariance between assets i and j ( ) equals the correlation of assets and ( ) multiplied by their respective aftertax standard deviations ( and ): (15) The use of standard deviation and covariance as above is in contrast to the H&A method where the beta measure is used. We choose to avoid using beta as the meanvariance optimisation model should be based on total risk, not market risk. We explain the impact of this decision further in the next section. Empirical Results In this section we apply our modifications to the H&A method by using aftertax input parameters as outlined above. We use the same initial inputs as the H&A paper to facilitate comparison of our results to theirs and these are presented in Panel A of Table 1. Panels B and C show the taxadjusted inputs using the H&A method and our method respectively. [Table 1 here] 10
11 Most of the differences between the two methods lie in the taxable account. As mentioned in the previous section, we do avoid using a beta term in our method, unlike H&A. When dealing with meanvariance optimisation matrices, the covariance matrices pick up the covariation between the idiosyncratic returns, choosing the highest return for any given level of risk. By using beta in their model, H&A inherently consider only market risk, instead of total risk, creating a fundament flaw in their model. This shortcoming is apparent when looking at the taxadjusted inputs for bonds in the taxable account in Panel B. The taxadjusted standard deviation in the taxable account drops from 6% pretax to 2.1% aftertax a huge 65% drop, while the taxadjusted return is reduced by a mere 9%, even although bond returns are taxed at a rate of 30%. Instead, our method adjusts the actual standard deviation (the total risk, not just the market risk) of the asset, yielding a taxadjusted standard deviation of 4.2% (Panel C). With respect to the taxadjusted bond returns, the H&A method assumes that the government only shares in the market risk premium and not the base return for the riskfree rate. As a relatively small portion of bond returns is reward for market risk, this assumption means that bonds are largely taxfree! The reality, however, is that the government shares in the entire return. Therefore, our method imposes taxes on both the market premium as well as the riskfree component resulting in a taxadjusted return of 2.8% for the taxable account s bonds, a 30% drop from pretax levels commensurate with a 30% tax rate. For the taxable account s equity return their assumption is not an issue because the market risk of the equities is also its total risk. There are marked differences between the methods for the taxable account for the present value of the embedded tax liability and the equity rate of return. While this is partly attributable to the nontaxation of the riskfree component of return, it is also a result of the way in which deferred capital gains are dealt with. The H&A method deducts the future 11
12 deferred capital gains taxes from the initial principal value rather than the annual return. Our method takes a more intuitive approach, acknowledging that future capital gains taxes generated are part of that period s return and not an existing liability. This results in our method reaching a relatively small present value for the tax liability at 0.66% of pretax wealth, compared to 7.5% for H&A. Also, our taxadjusted return is 6.47% compared to H&A s 7.43%, the latter ignoring tax on deferred gains and tax on the riskfree component. Finally, for the taxable account we deduct the present value of the tax liability from the cash allocation rather than from the equity allocation, which more correctly reflects the loan from the government. With our assumption of 10% embedded capital gains, this creates a slight leveraging effect within the taxable account. By contrast, in adjusting the taxable account for all existing and future deferred capital gains, the H&A method overadjusts for taxes in the taxable account compared to the TDA and Roth accounts. This is evident in the difference between posttax allocations of wealth. Following the H&A model would result in 40% of posttax wealth attributable to the taxable account compared to a 45% posttax wealth allocation with our model. Table 2 presents the efficient frontiers resulting from the two methods, along with the resulting asset allocations for each point along the frontier. The optimisation routine varies the pretax weights in each asset, subject to borrowing and lending restrictions that ensure that no short selling occurs and that maximum investment in each category does not exceed its initial endowment. Because the Roth account and TDA have identical aftertax returns after the TDA s principal value has been adjusted, we hold the ratio of equity to bonds constant between these two accounts. xii Table 2 presents the asset allocations based on pretax principal weights, although the posttax asset weights (not reported here) are used to calculate the portfolio s return and risk. [Table 2 here] 12
13 Both methods produce a consistent reduction in the overall allocation of equity across the accounts, as expected. The H&A method in Panel A shows that in order to reduce risk, investors should start reducing allocation to risky assets in their retirement accounts. However, this trend is not monotonic about half way down the risk spectrum, investors should switch the entire portion of equity to bonds in the taxable account for the lower half of the risk spectrum. In their paper, they also comment on a preference to replace equity in the TDA rather than in the Roth account (p. 68), but this can be attributed to the optimisation routine, because both accounts have the same taxadjusted inputs. xiii Our results in Panel B create an even stronger, and more monotonic, preference for holding equities within the taxable account, suggesting that investors switch to bonds in the retirement accounts first. The only exception is at the bottom end of the spectrum, where 0% equity is held in the taxable account, and a small portion of the retirement account is held in equities. This leads us to conclude that all but the most risk averse investors should maintain a 100% allocation to equities in the taxable account and adjust their risk by switching to bonds in their retirement accounts. This preference for holding equities in the taxable account is most likely due to the relatively favourable taxation of equity returns compared to bond returns, which leads to an increased aftertax market risk premium. These findings bring the H&A results in line with other works in the literature. The first body of work is Leibowitz (2003), and Leibowitz and Bova (2009) who succinctly illustrate the increased aftertax market risk premium. And second, the work of Dammon, Spatt and Zhang (2004) who find a preference for investing the taxable account balance into equities, and the taxdeferred account balance into bonds. In the latter study, the authors examine the case in an intertemporal context, and use numerical methods to calculate the optimal allocation and locations. The confirmation of their multi period findings with our single period model 13
14 further suggests that our model is picking up some extra timing effects that the H&A method was missing. [Figure 1 here] So how do these efficient frontiers compare? Figure 1 plots the meanvariance efficient frontiers using the results from Table 2 together with the pretax efficient frontier. Our model creates a noticeable downward shift in the efficient frontier when compared to the H&A paper. In other words, the aftertax efficient frontier is less efficient than what was suggested by H&A. This shift is attributable to two reasons. First, H&A do not adjust the riskfree component of returns and only tax the beta component of returns. Second, they adjust for change in deferred capital gains in the posttax principal value while we adjust for this in the expected returns. [Figure 2 here] Assuming that our method reveals the true posttax meanvariance optimisation, how inefficient are the allocations suggested by the H&A model, and a naive tax unaware model that calculates a single risky weight, and applies this to all tax environments? Figure 2 plots these results, and surprisingly, the H&A method is less efficient than the naive allocation generated in the pretax method! xiv The underperformance is most noticeable in the middle of the risk spectrum, and at a standard deviation of 8.7% the H&A method underperforms by 15.8 basis points while the pretax method underperforms by just 6.7 basis points. Over a 20 year investment period, the investor could expect to have up to 3.2% more wealth at retirement using our improved method, instead of H&A s method. We expect that our method would consistently outperform the alternative methods, even in the presence of estimation error. [Figure 3 here] 14
15 As a final comparison, we examine how each model values deferred capital gains. For the H&A method, they implicitly discount the deferred capital gains using an aftertax discount rate of 7.43% for equity. We, on the other hand, use the aftertax return of the riskfree rate to calculate present values. The capital gains tax multiplier for both methods are displayed in Figure 3. By using a higher discount rate, the H&A model finds the present value of deferred capital gains tax to be a mere 5.7% of its future value after 40 years. The corresponding estimate using our method is 43.5%. Our approach shows that considering the impact of deferred capital gains on wealth, be they existing embedded capital gains or future capital gains yet to be accrued, is important even at longer time horizons. Conclusion This study advanced the literature on dealing with taxation in a meanvariance optimisation model in a number of important ways. Firstly, it acknowledged the leveraging effect caused by embedded capital gains, as a result of the implicit interestfree loan from the government. Using this insight, we explained how the investor s risk can be returned to a nonleveraged level using riskfree investments, and concluded that this rate is therefore the most appropriate to use when valuing these implicit future tax liabilities. This approach correctly incorporates the time value of money and the change in the nature of the risk to the investor. We adapted the model used by H&A using this new method to value embedded capital gains, while making a number of other minor adjustments such as ensuring that total investment risk is adjusted for taxes, and not just for market risk. Using our approach, the effective posttax asset allocations are adjusted for embedded capital gains. Subsequently, expected returns and standard deviations are adjusted for the present value of any new or reduced deferred capital gains generated during that period. We find that the presence of embedded taxes increases the investor s equity risk and must be considered when calculating their current asset allocation. Our findings also suggest that 15
16 investors should prefer holding their risky assets (like stocks) in the tax environment with the highest tax rate and prefer to hold fixed income assets (like bonds) in their retirement accounts. This most important finding contradicts the traditional investment heuristic that retirement accounts are more suited to taking on equity risk due to their long investment horizon, and increased tolerance for risk. This confirms and strengthens the findings of Horan and Al Zaman (2008). Furthermore, these findings support the results of Dammon, Spatt and Zhang (2004) who use a numerical approach, and also Leibowitz and Bova (2009) who show that the presence of taxes increases the equity risk premium by taxing bond returns at higher average rate than equity returns. 16
17 Table 1. PreTax and TaxAdjusted MeanVariance Inputs Notes: This table displays the pretax and posttax meanvariance inputs for our improved method and that of Horan and Al Zaman (2008). The riskfree rate is assumed to be 3%. *The 0.76% allocation to bonds is actually the allocation to the riskfree rate. 17
18 Table 2. TaxAdjusted MeanVariance Efficient Frontiers and Asset Allocations Notes: This table compares the meanvariance efficient asset allocations computed using our improved method and that of Horan and Al Zaman (2008). The meanvariance inputs are from Table 1. While the expected returns and standard deviations are based on the posttax weights, the displayed asset allocations are pretax. 18
19 Figure 1. Pre and Posttax MeanVariance Efficient Frontiers Notes: This graph compares the posttax efficient frontiers of our improved method with that of Horan and Al Zaman (2008). 19
20 Figure 2. MeanVariance Efficient Frontiers Notes: This graph shows the relative inefficiency of the naïve (pretax) and the Horan and Al Zaman optimal weights compared to the improved method. 20
21 Figure 3. Present Value of Tax Liabilities with Different Investment Horizons Notes: This graph compares the reduction in the present value of the capital gains tax over time for our improved method with that of Horan and Al Zaman (2008). 21
22 References Arnott, R. D., Berkin, A. L., & Ye, J. (2000). How Well Have Taxable Investors Been Served in the 1980s and 1990s? Journal of Portfolio Management, 26(4), Berkin, A. L., & Luck, C. G. (2010). Having Your Cake and Eating It Too: The Before and AfterTax Efficiencies of an Extended Equity Mandate. Financial Analysts Journal, 66(4), Dammon, R. M., Spatt, C. S., & Zhang, H. H. (2004). Optimal Asset Location and Allocation with Taxable and TaxDeferred Investing. Journal of Finance, 59(3), Horan, S. M. (2007). Applying AfterTax Asset Allocation. The Journal of Wealth Management, 10(2), Horan, S. M., & Al Zaman, A. (2008). TaxAdjusted Portfolio Optimization and Asset Location: Extensions and Synthesis. Journal of Wealth Management, 11(3), Leibowitz, M. L. (2003). The Higher Equity Risk Premium Created by Taxation. [Article]. Financial Analysts Journal, 59(5), Leibowitz, M. L., & Bova, A. (2009). ReturnRisk Ratios Under Taxation. Journal of Portfolio Management, 35(4), Reichenstein, W. (2006). AfterTax Asset Allocation. Financial Analysts Journal, 62(4), Reichenstein, W. (2007a). Calculating AfterTax Asset Allocation Is Key To Determining Risk, Returns and Asset Location. Journal of Financial Planning, 20(7), Reichenstein, W. (2007b). Implications of Principal, Risk, and Returns Sharing Across Savings Vehicles. Financial Services Review, 16(1), Reichenstein, W. (2007c). Note on "Applying AfterTax Asset Allocation". Journal of Wealth Management, 10(2), Reichenstein, W. (2008a). How to Calculate an AfterTax Asset Allocation. Journal of Financial Planning, 21(8), Reichenstein, W. (2008b). One Concept and Some of Its Applications. Journal of Wealth Management, 11(3), Wilcox, J., Horvitz, J. E., & dibartolomeo, D. (2006). Investment Management for Taxable Private Investors: Research Foundation of CFA Institute. 22
23 Notes i See, for example, Wilcox, Horvitz & dibartolomeo (2006). ii Embedded Tax Liabilities are only incurred by mutual fund investors and not by individuals who invest via separate accounts or hedge funds. They are also only incurred by taxable accounts. iii Leibowitz (2003) discusses the implication of preferential taxation, finding that although the total return reduces, the risk premium associated with market risk actually increases. (See also Leibowitz & Bova, 2009). iv Taxable accounts are the normal tax accounts as opposed to the concessionallytaxed retirement accounts. v Note that a TDA can be considered taxfree if you notionally adjust the principal value down by 30%, because adjusting the final wealth value for tax at the end is equivalent to adjusting it at the beginning ( ). Using this knowledge, the number of effective tax environments can be reduced to two. vi The derivation of this approximation is shown in the appendix of Horan (2007). vii Note that in a more realistic setting, where taxes are asymmetrical and the government only shares in positive returns it is likely that correlations would change. viii There is an oddity in these adjustments. This oddity lies in the use of beta in the calculations, which in effect is calculating the investments systematic risk, when optimisation models specifically call for the total risk of the asset. This is an obvious error when one sets the tax rate to 0%. ix Reichenstein addresses this in an article discussing what he describes as their philosophical differences. Reichenstein illustrates that under Horan and Al Zaman s equation in (7), when the investment horizon is set to 1, with a riskfree rate of 5% and a tax rate of 30% present value becomes: $1 $1. $ Surely $1 held in a bank account. today is worth $1 today! x A new riskfree asset must be introduced to the model if one does not already exist. Alternatively, this can be deducted from the bond allocation, although it will lead to a slight discrepancy between the investor s true risk and the risk portrayed by the model. xi For practitioners it is generally fairly easy to manipulate the timing of capital gains, for example to occur at the beginning of the n+1 period instead of at the end of the nth period, so this discounting formula could just as easily be n instead of n1. In order to maintain consistency, if n is used in equation (13), then n+1 should be used in formulas (10) and (11). The difference between the two approaches is marginal. xii Horan and Al Zaman (2008) do not hold this ratio constant. However, it is held constant for both our method and the H&A model. xiii This optimisation problem is not an issue here because the split between equity and bonds between the TDA and Roth accounts is the same. xiv A strategy that prefers to hold equities in the superannuation account, and cash in the taxable account would have similar inefficiencies to the H&A model in the lower part of the frontier, but worse in the upper part. 23
The Tax Benefits and Revenue Costs of Tax Deferral
The Tax Benefits and Revenue Costs of Tax Deferral Copyright 2012 by the Investment Company Institute. All rights reserved. Suggested citation: Brady, Peter. 2012. The Tax Benefits and Revenue Costs of
More informationREADING 11: TAXES AND PRIVATE WEALTH MANAGEMENT IN A GLOBAL CONTEXT
READING 11: TAXES AND PRIVATE WEALTH MANAGEMENT IN A GLOBAL CONTEXT Introduction Taxes have a significant impact on net performance and affect an adviser s understanding of risk for the taxable investor.
More informationThe Investment Implications of TaxDeferred vs. Taxable Accounts
FEATURE While asset allocation is the most important decision an investor can make, allocating a given mix among accounts with different tax structures can be a taxing question. The Investment Implications
More informationRetirement Investing: Analyzing the Roth Conversion Option*
Retirement Investing: Analyzing the Roth Conversion Option* Robert M. Dammon Tepper School of Bsiness Carnegie Mellon University 12/3/2009 * The author thanks Chester Spatt for valuable discussions. The
More informationManaging Home Equity to Build Wealth By Ray Meadows CPA, CFA, MBA
Managing Home Equity to Build Wealth By Ray Meadows CPA, CFA, MBA About the Author Ray Meadows is the president of Berkeley Investment Advisors, a real estate brokerage and investment advisory firm. He
More informationIn this article, we go back to basics, but
Asset Allocation and Asset Location Decisions Revisited WILLIAM REICHENSTEIN WILLIAM REICHENSTEIN holds the Pat and Thomas R. Powers Chair in Investment Management at the Hankamer School of Business at
More informationIn the Presence of Taxes: Applications of Aftertax Asset Valuations,
Taxes Exist! Implications for Asset Allocation, Location, and Withdrawal Strategies es in Retirement e e Thornburg Asset Management September 19, 2011 William Reichenstein, PhD, CFA Powers Professor of
More informationWharton Financial Institutions Center Policy Brief: Personal Finance. Measuring the Tax Benefit of a TaxDeferred Annuity
Wharton Financial Institutions Center Policy Brief: Personal Finance Measuring the Tax Benefit of a TaxDeferred Annuity David F. Babbel* Fellow, Wharton Financial Institutions Center babbel@wharton.upenn.edu
More informationWhy is Life Insurance a Popular Funding Vehicle for Nonqualified Retirement Plans?
Why is Life Insurance a Popular Funding Vehicle for Nonqualified Retirement Plans? By Peter N. Katz, JD, CLU ChFC This article is a sophisticated analysis about the funding of nonqualified retirement plans.
More informationNonqualified Annuities in Aftertax Optimizations
May 11, 2005 Nonqualified Annuities in Aftertax Optimizations By William Reichenstein Abstract This study first explains why individuals should calculate an aftertax asset allocation. This asset allocation
More informationt = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3
MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate
More informationDeferred Compensation in a Rising Tax Environment
Deferred Compensation in a Rising Tax Environment An analysis of the relative advantage of deferral under multiple tax, timing, and return scenarios By Eric Wittenmyer and Joe Roth Aon Consulting Executive
More informationLIQUIDATING RETIREMENT ASSETS
LIQUIDATING RETIREMENT ASSETS IN A TAXEFFICIENT MANNER By William A. Raabe and Richard B. Toolson When you enter retirement, you retire from work, not from decisionmaking. Among the more important decisions
More informationRESEARCH FOUNDATION OF CFA INSTITUTE MONOGRAPH. TaxAdvantaged Savings Accounts and TaxEfficient Wealth Accumulation
Research Foundation of CFA Institute Monograph 69 RESEARCH FOUNDATION OF CFA INSTITUTE MONOGRAPH TaxAdvantaged Savings Accounts and TaxEfficient Wealth Accumulation Stephen M. Horan, CFA Research Foundation
More informationSolution: The optimal position for an investor with a coefficient of risk aversion A = 5 in the risky asset is y*:
Problem 1. Consider a risky asset. Suppose the expected rate of return on the risky asset is 15%, the standard deviation of the asset return is 22%, and the riskfree rate is 6%. What is your optimal position
More informationFundamentals Level Skills Module, Paper F9
Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2008 Answers 1 (a) Rights issue price = 2 5 x 0 8 = $2 00 per share Theoretical ex rights price = ((2 50 x 4) + (1 x 2 00)/5=$2
More informationEffective Tax Management for Investment Portfolios
Effective Tax Management for Investment Portfolios Tax management in investment portfolios for Australia s private wealth holders. Matching Investments to their Holding Structures March 2013 Private Portfolio
More informationFinancial advisors are asked to assist their clients in
Which Would You Choose: Funding Retirement or Paying Off Consumer Debt? By James M. Grayson, Ph.D.; Peter M. Basciano, Ph.D.; and Christopher L. Cain, J.D., Ph.D., CFA EXECUTIVE SUMMARY Paying off consumer
More informationFundamentals Level Skills Module, Paper F9
Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2008 Answers 1 (a) Calculation of weighted average cost of capital (WACC) Cost of equity Cost of equity using capital asset
More informationOptimal Asset Location and Allocation with Taxable and TaxDeferred Investing
THE JOURNAL OF FINANCE VOL. LIX, NO. 3 JUNE 2004 Optimal Asset Location and Allocation with Taxable and TaxDeferred Investing ROBERT M. DAMMON, CHESTER S. SPATT, and HAROLD H. ZHANG ABSTRACT We investigate
More information15.433 Investments. Assignment 1: Securities, Markets & Capital Market Theory. Each question is worth 0.2 points, the max points is 3 points
Assignment 1: Securities, Markets & Capital Market Theory Each question is worth 0.2 points, the max points is 3 points 1. The interest rate charged by banks with excess reserves at a Federal Reserve Bank
More informationModule 7 Asset pricing models
1. Overview Module 7 Asset pricing models Prepared by Pamela Peterson Drake, Ph.D., CFA Asset pricing models are different ways of interpreting how investors value investments. Most models are based on
More informationLecture 2: Equilibrium
Lecture 2: Equilibrium Investments FIN460Papanikolaou Equilibrium 1/ 33 Overview 1. Introduction 2. Assumptions 3. The Market Portfolio 4. The Capital Market Line 5. The Security Market Line 6. Conclusions
More informationDraft. This article challenges two features of. Calculating Asset Allocation WILLIAM REICHENSTEIN
Calculating Asset Allocation WILLIAM REICHENSTEIN WILLIAM REICHENSTEIN holds the Pat and thomas R. Powers Chair in investment management at Baylor University, Waco, Texas. This article challenges two features
More informationTax Cognizant Portfolio Analysis: A Methodology for Maximizing After Tax Wealth
Tax Cognizant Portfolio Analysis: A Methodology for Maximizing After Tax Wealth Kenneth A. Blay Director of Research 1st Global, Inc. Dr. Harry M. Markowitz Harry Markowitz Company CFA Society of Austin
More informationCHAPTER 10 ANNUITIES
CHAPTER 10 ANNUITIES are contracts sold by life insurance companies that pay monthly, quarterly, semiannual, or annual income benefits for the life of a person (the annuitant), for the lives of two or
More informationUniversity of Pennsylvania The Wharton School
University of Pennsylvania The Wharton School FNCE 100 PROBLEM SET #6 Fall Term 2005 A. Craig MacKinlay Capital Structure 1. The XYZ Co. is assessing its current capital structure and its implications
More information6. Debt Valuation and the Cost of Capital
6. Debt Valuation and the Cost of Capital Introduction Firms rarely finance capital projects by equity alone. They utilise long and short term funds from a variety of sources at a variety of costs. No
More informationTRENDS AND ISSUES TaxEfficient Sequencing Of Accounts to Tap in Retirement
TaxEfficient Sequencing Of Accounts to Tap in Retirement By William Reichenstein, Ph.D., TIAACREF Institute Fellow, Baylor University October 2006 EXECUTIVE SUMMARY This study discusses strategies for
More informationAre you satisfied with the progress you ve made toward your retirement?
Are you satisfied with the progress you ve made toward your retirement? Neither New York Life Insurance Company nor its agents provides tax, legal, or accounting advice. Please consult your own tax, legal,
More informationCHAPTER 21: OPTION VALUATION
CHAPTER 21: OPTION VALUATION 1. Put values also must increase as the volatility of the underlying stock increases. We see this from the parity relation as follows: P = C + PV(X) S 0 + PV(Dividends). Given
More informationInstructor s Manual Chapter 12 Page 144
Chapter 12 1. Suppose that your 58yearold father works for the Ruffy Stuffed Toy Company and has contributed regularly to his companymatched savings plan for the past 15 years. Ruffy contributes $0.50
More informationNIKE Case Study Solutions
NIKE Case Study Solutions Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the
More informationMaking Retirement Assets Last a Lifetime PART 1
Making Retirement Assets Last a Lifetime PART 1 The importance of a solid exit strategy During the working years, accumulating assets for retirement is one of the primary goals of the investing population.
More informationWithdrawal Strategies to Make Your Nest Egg Last Longer
Withdrawal Strategies to Make Your Nest Egg Last Longer Ibbotson Associates/IFID Centre Retirement Income Products Executive Symposium William Reichenstein, PhD, CFA Baylor University 1 Presentation based
More informationThe Asset Allocation Worksheet: Version 1.2
The Asset Allocation Worksheet: Version 1.2 David J. Grabiner February 3, 2013 Changes from version 1.1: Corrected tax rate computation on taxable account to be the fraction of gains lost to taxes. Adjusted
More informationFinal Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator
University of Stavanger (UiS) Stavanger Masters Program Final Exam MØA 155 Financial Economics Fall 2009 Permitted Material: Calculator The number in brackets is the weight for each problem. The weights
More informationMidterm Exam:Answer Sheet
Econ 497 Barry W. Ickes Spring 2007 Midterm Exam:Answer Sheet 1. (25%) Consider a portfolio, c, comprised of a riskfree and risky asset, with returns given by r f and E(r p ), respectively. Let y be the
More informationRethinking Fixed Income
Rethinking Fixed Income Challenging Conventional Wisdom May 2013 Risk. Reinsurance. Human Resources. Rethinking Fixed Income: Challenging Conventional Wisdom With US Treasury interest rates at, or near,
More informationQuestion 1. Marking scheme. F9 ACCA June 2013 Exam: BPP Answers
Question 1 Text references. NPV is covered in Chapter 8 and real or nominal terms in Chapter 9. Financial objectives are covered in Chapter 1. Top tips. Part (b) requires you to explain the different approaches.
More informationContribution 787 1,368 1,813 983. Taxable cash flow 682 1,253 1,688 858 Tax liabilities (205) (376) (506) (257)
Answers Fundamentals Level Skills Module, Paper F9 Financial Management June 2012 Answers 1 (a) Calculation of net present value (NPV) As nominal aftertax cash flows are to be discounted, the nominal
More information9. Himal Trading has EBIT of Rs 80,000, interest expense of Rs 12,000, and preferred
Set A Fundamentals of Financial Management Model Questions 2072 Program: BBS Time: 3 Hours Part: III F.M.: 100 Code: MGT 215 P.M.: 35 The objective of the model questions is to give an overview of the
More informationHistorically, investors managing retirement
August 2011 By Robert S. Keebler Tax Management of Retirement Savings Vehicles Historically, investors managing retirement savings vehicles focused solely on pretax returns. Taxes were not a consideration
More informationPersonal Financial Plan. John & Mary Sample
For Prepared by Donald F. Dempsey Jr. PO Box 1591 Williston, VT 05495 8027645815 This presentation provides a general overview of some aspects of your personal financial position. It is designed to provide
More informationModels of Risk and Return
Models of Risk and Return Aswath Damodaran Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for
More informationLife Cycle Asset Allocation A Suitable Approach for Defined Contribution Pension Plans
Life Cycle Asset Allocation A Suitable Approach for Defined Contribution Pension Plans Challenges for defined contribution plans While Eastern Europe is a prominent example of the importance of defined
More informationAsymmetry and the Cost of Capital
Asymmetry and the Cost of Capital Javier García Sánchez, IAE Business School Lorenzo Preve, IAE Business School Virginia Sarria Allende, IAE Business School Abstract The expected cost of capital is a crucial
More informationSome proven financial advice strategies
Some proven financial advice strategies There are numerous key financial advice strategies that may put you on the road to achieving your financial goals Debt Management Debt consolidation can lower repayments
More informationFIN 3710. Final (Practice) Exam 05/23/06
FIN 3710 Investment Analysis Spring 2006 Zicklin School of Business Baruch College Professor Rui Yao FIN 3710 Final (Practice) Exam 05/23/06 NAME: (Please print your name here) PLEDGE: (Sign your name
More informationChapter 3: Commodity Forwards and Futures
Chapter 3: Commodity Forwards and Futures In the previous chapter we study financial forward and futures contracts and we concluded that are all alike. Each commodity forward, however, has some unique
More informationThe IRA opportunity: To Roth or not to Roth?
The IRA opportunity: To Roth or not to Roth? Vanguard research July 2011 Executive summary. The year 2010, which may well go down in IRA history as the year of the Roth, saw three notable legislative changes
More informationMODERN PORTFOLIO THEORY AND INVESTMENT ANALYSIS
MODERN PORTFOLIO THEORY AND INVESTMENT ANALYSIS EIGHTH EDITION INTERNATIONAL STUDENT VERSION EDWIN J. ELTON Leonard N. Stern School of Business New York University MARTIN J. GRUBER Leonard N. Stern School
More informationReview for Exam 2. Instructions: Please read carefully
Review for Exam 2 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems You are not responsible for any topics that are not covered in the lecture note
More informationPractice Set #4 and Solutions.
FIN469 Investments Analysis Professor Michel A. Robe Practice Set #4 and Solutions. What to do with this practice set? To help students prepare for the assignment and the exams, practice sets with solutions
More informationCAPM, Arbitrage, and Linear Factor Models
CAPM, Arbitrage, and Linear Factor Models CAPM, Arbitrage, Linear Factor Models 1/ 41 Introduction We now assume all investors actually choose meanvariance e cient portfolios. By equating these investors
More informationTRENDS AND ISSUES TAXEFFICIENT SAVING AND INVESTING. By William Reichenstein, Ph.D., TIAACREF Institute Fellow, Baylor University
TAXEFFICIENT SAVING AND INVESTING By William Reichenstein, Ph.D., TIAACREF Institute Fellow, Baylor University February 2006 EXECUTIVE SUMMARY A central component of investment advice in recent decades
More informationLeverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview
Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for
More informationThis is the tradeoff between the incremental change in the risk premium and the incremental change in risk.
I. The Capital Asset Pricing Model A. Assumptions and implications 1. Security markets are perfectly competitive. a) Many small investors b) Investors are price takers. Markets are frictionless a) There
More informationValuing the Business
Valuing the Business 1. Introduction After deciding to buy or sell a business, the subject of "how much" becomes important. Determining the value of a business is one of the most difficult aspects of any
More informationThe Tangent or Efficient Portfolio
The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of rewardtovolatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r
More informationLecture 15: Final Topics on CAPM
Lecture 15: Final Topics on CAPM Final topics on estimating and using beta: the market risk premium putting it all together Final topics on CAPM: Examples of firm and market risk Shorting Stocks and other
More informationThe single source for all your executive benefit needs. A Primer on. Nonqualified Deferred
M Benefit Solutions The single source for all your executive benefit needs A Primer on Nonqualified Deferred Compensation Plans DISCLOSURE INFORMATION This material is intended for informational purposes
More informationRetirement Investing: Analyzing the Roth Conversion and Recharacterization Options. Robert Dammon,* Chester Spatt,** and. Harold H.
Retirement Investing: Analyzing the Roth Conversion and Recharacterization Options by Robert Dammon,* Chester Spatt,** and Harold H. Zhang*** February 20, 2010 * Tepper School of Business, Carnegie Mellon
More informationAchievement of MarketFriendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development
Achievement of MarketFriendly Initiatives and Results Program (AMIR 2.0 Program) Funded by U.S. Agency for International Development Equity Analysis, Portfolio Management, and Real Estate Practice Quizzes
More informationTPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II + III
TPPE17 Corporate Finance 1(5) SOLUTIONS REEXAMS 2014 II III Instructions 1. Only one problem should be treated on each sheet of paper and only one side of the sheet should be used. 2. The solutions folder
More informationThe Equity Premium in India
The Equity Premium in India Rajnish Mehra University of California, Santa Barbara and National Bureau of Economic Research January 06 Prepared for the Oxford Companion to Economics in India edited by Kaushik
More informationThis strategy gives a person the ability to take advantage of the taxsheltering ability of a life insurance policy.
Insuring the Future In this Newsletter: Supplementing Retirement Income Who should be looking at this strategy? The Registered Savings Problem John Jordan, CFP CERTIFIED FINANCIAL PLANNER Phone: (519)
More informationLecture 1: Asset Allocation
Lecture 1: Asset Allocation Investments FIN460Papanikolaou Asset Allocation I 1/ 62 Overview 1. Introduction 2. Investor s Risk Tolerance 3. Allocating Capital Between a Risky and riskless asset 4. Allocating
More informationThe cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction
The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal
More informationSummary Prospectus September 28, 2015 PNC S&P 500 Index Fund Class A PIIAX Class C PPICX Class I PSXIX Class R4 PSPEX Class R5 PSFFX
Summary Prospectus September 28, 2015 PNC S&P 500 Index Fund Class A PIIAX Class C PPICX Class I PSXIX Class R4 PSPEX Class R5 PSFFX Before you invest, you may want to review the Fund s Prospectus, which
More informationINSURANCE. Life Insurance. as an. Asset Class
INSURANCE Life Insurance as an Asset Class 16 FORUM JUNE / JULY 2013 Permanent life insurance has always been an exceptional estate planning tool, but as Wayne Miller and Sally Murdock report, it has additional
More informationBasic Investment Education
Disclaimer: The information provided below is for information purposes only  it is not investment advice. If you have any questions about your own personal financial situation, you should consult with
More informationSmart strategies for maximising retirement income
Smart strategies for maximising retirement income 2010 Why you need to create a lifelong income Australia has one of the highest life expectancies in the world and the average retirement length has increased
More informationIRAs: Four Facts You Should Know
IRAs: Four Facts You Should Know Overview: The decision between contributing to a traditional 2007 IRA and a Roth IRA depends on many factors. The following discusses some of the key concepts to consider
More informationChapter 19 Retirement Products: Annuities and Individual Retirement Accounts
Chapter 19 Retirement Products: Annuities and Individual Retirement Accounts Overview Thus far we have examined life insurance in great detail. Life insurance companies also market a product that addresses
More informationA research study issued by the ASX and Russell Investments. Investing Report FULL REPORT / JUNE 2012
A research study issued by the ASX and Russell Investments LongTerm Investing Report FULL REPORT / JUNE 2012 Helping everybody invest intelligently by offering a deeper insight into investment markets
More informationManaged funds. Plain Talk Library
Plain Talk Library Contents Introduction to managed funds 5 What is a managed fund and how does it work? 6 Types of managed funds 12 What are the benefits of managed funds? 15 Choosing a managed fund
More informationUnderstanding Investment Leverage
Understanding Investment Leverage Understanding Investment Leverage What is investment leverage? Each year, more and more Canadians are taking advantage of a simple yet powerful wealthcreation strategy
More informationThere are two types of returns that an investor can expect to earn from an investment.
Benefits of investing in the Stock Market There are many benefits to investing in shares and we will explore how this common form of investment can be an effective way to make money. We will discuss some
More informationShould Banks Trade Equity Derivatives to Manage Credit Risk? Kevin Davis 9/4/1991
Should Banks Trade Equity Derivatives to Manage Credit Risk? Kevin Davis 9/4/1991 Banks incur a variety of risks and utilise different techniques to manage the exposures so created. Some of those techniques
More informationWharton Financial Institutions Center Personal Finance. Measuring the Tax Benefit of a TaxDeferred Annuity
Wharton Financial Institutions Center Personal Finance Measuring the Tax Benefit of a TaxDeferred Annuity David F. Babbel* The Wharton School of Business University of Pennsylvania 3620 Locust Walk, SHDH
More informationRetirement Investing: Analyzing the Roth Conversion and Recharacterization Options. Robert Dammon,* Chester Spatt,** and. Harold H.
Retirement Investing: Analyzing the Roth Conversion and Recharacterization Options by Robert Dammon,* Chester Spatt,** and Harold H. Zhang*** July 22, 2011 * Tepper School of Business, Carnegie Mellon
More informationCHAPTER 9: THE CAPITAL ASSET PRICING MODEL
CHAPTER 9: THE CAPITAL ASSET PRICING MODEL PROBLEM SETS 1. E(r P ) = r f + β P [E(r M ) r f ] 18 = 6 + β P(14 6) β P = 12/8 = 1.5 2. If the security s correlation coefficient with the market portfolio
More informationCh. 18: Taxes + Bankruptcy cost
Ch. 18: Taxes + Bankruptcy cost If MM1 holds, then Financial Management has little (if any) impact on value of the firm: If markets are perfect, transaction cost (TAC) and bankruptcy cost are zero, no
More informationCHAPTER 21: OPTION VALUATION
CHAPTER 21: OPTION VALUATION PROBLEM SETS 1. The value of a put option also increases with the volatility of the stock. We see this from the putcall parity theorem as follows: P = C S + PV(X) + PV(Dividends)
More informationFIN 432 Investment Analysis and Management Review Notes for Midterm Exam
FIN 432 Investment Analysis and Management Review Notes for Midterm Exam Chapter 1 1. Investment vs. investments 2. Real assets vs. financial assets 3. Investment process Investment policy, asset allocation,
More informationHKAS 12 Revised May November 2014. Hong Kong Accounting Standard 12. Income Taxes
HKAS 12 Revised May November 2014 Hong Kong Accounting Standard 12 Income Taxes HKAS 12 COPYRIGHT Copyright 2014 Hong Kong Institute of Certified Public Accountants This Hong Kong Financial Reporting Standard
More informationCorporate Income Taxation
Corporate Income Taxation We have stressed that tax incidence must be traced to people, since corporations cannot bear the burden of a tax. Why then tax corporations at all? There are several possible
More informationCHAPTER 22: FUTURES MARKETS
CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support
More informationSAMPLE MIDTERM QUESTIONS
SAMPLE MIDTERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,
More informationEquity Valuation. Lecture Notes # 8. 3 Choice of the Appropriate Discount Rate 2. 4 Future Cash Flows: the Dividend Discount Model (DDM) 3
Equity Valuation Lecture Notes # 8 Contents About Valuation 2 2 PresentValues 2 3 Choice of the Appropriate Discount Rate 2 4 Future Cash Flows: the Dividend Discount Model (DDM) 3 5 The TwoStage DividendGrowth
More informationThe Mechanics of Corporate Class
The Mechanics of Corporate Class How Corporate Class works Whether your clients have investments in their corporate accounts, nonregistered investments or both, the tax efficiency of their investments
More informationNexGen Tax Cases The Corporate Tax Deferral and Income Program
2014 NexGen Tax Cases The Corporate Tax Deferral and Income Program Business owners and managers in Canada who have incorporated have two major income tax advantages available to them over those who have
More information1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600 1,600 1,600 1,600 1,600
Answers Fundamentals Level Skills Module, Paper F9 Financial Management December 2011 Answers 1 (a) Calculation of net present value (NPV) Year 1 2 3 4 5 6 $000 $000 $000 $000 $000 $000 Sales revenue 1,600
More informationSPDR Wells Fargo Preferred Stock ETF
SPDR Wells Fargo Preferred Stock ETF Summary ProspectusOctober 31, 2015 PSK (NYSE Ticker) Before you invest in the SPDR Wells Fargo Preferred Stock ETF (the Fund ), you may want to review the Fund's prospectus
More informationFinance 350: Problem Set 6 Alternative Solutions
Finance 350: Problem Set 6 Alternative Solutions Note: Where appropriate, the final answer for each problem is given in bold italics for those not interested in the discussion of the solution. I. Formulas
More informationNAVIPLAN PREMIUM LEARNING GUIDE. Net Worth
NAVIPLAN PREMIUM LEARNING GUIDE Net Worth Contents Investment accounts 1 Learning objectives 1 NaviPlan planning stages 1 Capture lifestyle assets 3 Lifestyle Asset Details dialog box Details section 4
More informationInstitute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management
Institute of Chartered Accountant Ghana (ICAG) Paper 2.4 Financial Management Final Mock Exam 1 Marking scheme and suggested solutions DO NOT TURN THIS PAGE UNTIL YOU HAVE COMPLETED THE MOCK EXAM ii Financial
More informationSmart strategies for maximising retirement income 2012/13
Smart strategies for maximising retirement income 2012/13 Why you need to create a life long income Australia has one of the highest life expectancies in the world and the average retirement length has
More informationAnnuities. Introduction 2. What is an Annuity?... 2. How do they work?... 3. Types of Annuities... 4. Fixed vs. Variable annuities...
An Insider s Guide to Annuities Whatever your picture of retirement, the best way to get there and enjoy it once you ve arrived is with a focused, thoughtful plan. Introduction 2 What is an Annuity?...
More information