Ch05: TaBS Flashcards
Clientele Arbitrage
this involves taking long and short positions in-differently taxed assets so that the net investment cost is 0 and the r is positive; long and short positions are based on the investors’ marginal tax rate.
High tax-bracket: long the tax-favored asset, short the taxable asset
Low tax-bracket: long the taxable asset, short the tax-favored asset
Organizational Arbitrage
Regardless of the investor’s mtr, he would long the tax-favored asset and short the disfavored-tax asset.
Total Tax Paid (ttp)
In competitive equilibrium, the ttp is the same for all assets.
implicit tax + explicit tax
(Rb - Ra) + (Ra - r)
Rb - r
Implicit Tax Rate, (t.ia)
The implicit tax rate on the alternative investment (a) is the tax rate that, if applied as the explicit tax rate on the taxable asset (b), would result in a return on (b) equal to the pretax rate of return (Ra) on the alternative asset.
(Rb - Ra) / Rb Rb x (1 - t.ia)
Explicit Tax Rate, (etr)
(Ra - r*) / Rb
r*
The risk-adjusted after-tax r in competitive equilibrium
r* = Rm –> tax-exempt asset
R.0 - R.rp
R.0
Required pretax return before risk-adj.
This should be given at the top of the table
R.rp
Required pretax risk-premium
[r.rp / (1 - gt)]
R.rx
Required pretax risk-adj return from a risky asset; x could be any asset (taxable, tax-favored, tax-exempt)
R.0 - R.rp
Adjusting for Risk Differences, tax rates
R.rp is given
- Find the risk-adjusted pretax return from (b, a, or m) R.rx = R.0 - R.rp
- Explicit tax rate = [(R.rx - r*) / R.rx]
- Implicit tax rate:
Asset b: [(R.rb - R.rb) / R.rb]
Asset a: [(R.rb - R.ra) / R.rb]
Asset m: [(R.rb - r*) / R.rb]
Marginal Investors
taxpayers who are indifferent to purchasing equally risky investments whose returns are taxed differently
Inframarginal Investors
taxpayers with explicit tax-rates that are different from the explicit tax-rates marginal investors face ARE NOT indifferent to the choice of differently taxed assets
