P
PaperBeetle
Member
Q&A Bank 3, question 3.22 asks us to price a bond on which the investor will be paying income tax and perhaps capital gains tax. But there is a lag in the payment of the taxes. This ought to affect the formulation of the capital gains test? The q3.22 solution uses \[i^{(2)}>g(1-t_{1}{)}\] but working from first principles, I get the following (where w is the lag between the timing of the bond and the tax year, and where t2 may or may not be 0):
\[\require{enclose}
P=Ca_{\enclose{actuarial}{n}}^{(p)}-t_{1}v^{w}Ca_{\enclose{actuarial}{n}}+Rv^{n}-(R-P)t_{2}v^{n+w}
\]
which rearranges to
\[\require{enclose}
P(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2})=C(a_{\enclose{actuarial}{n}}^{(p)}-t_{1}v^{w}a_{\enclose{actuarial}{n}})
\]
But for capital gain, we have
\[R>P
{\implies}R(1-v^{n+w}t_{2})>P(1-v^{n+w}t_{2})\]
\[\require{enclose}
{\implies}R(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2})>P(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2}=C(a_{\enclose{actuarial}{n}}^{(p)}-t_{1}v^{w}a_{\enclose{actuarial}{n}})
\]
\[
{\implies}R(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2})>C(1-v^{n})(\frac{1}{i^{(p)}}-\frac{t_{1}v^{w}}{i})
\]
\[
{\implies}R-Rv^{n}-Rv^{n+w}t_{2}+Rv^{n+w}t_{2}>C(1-v^{n})(\frac{1}{i^{(p)}}-\frac{t_{1}v^{w}}{i})
\]
\[
{\implies}R>C(\frac{1}{i^{(p)}}-\frac{t_{1}v^{w}}{i})
\]
Sooooo... is the original version of the capital gains test just an approximation in this question? I guess there's only a small margin of capital gain that would fail one test but pass the other.
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.
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Sorry about the length, I just really like LATEX.
\[\require{enclose}
P=Ca_{\enclose{actuarial}{n}}^{(p)}-t_{1}v^{w}Ca_{\enclose{actuarial}{n}}+Rv^{n}-(R-P)t_{2}v^{n+w}
\]
which rearranges to
\[\require{enclose}
P(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2})=C(a_{\enclose{actuarial}{n}}^{(p)}-t_{1}v^{w}a_{\enclose{actuarial}{n}})
\]
But for capital gain, we have
\[R>P
{\implies}R(1-v^{n+w}t_{2})>P(1-v^{n+w}t_{2})\]
\[\require{enclose}
{\implies}R(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2})>P(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2}=C(a_{\enclose{actuarial}{n}}^{(p)}-t_{1}v^{w}a_{\enclose{actuarial}{n}})
\]
\[
{\implies}R(1-v^{n+w}t_{2})-Rv^{n}(1-v^{w}t_{2})>C(1-v^{n})(\frac{1}{i^{(p)}}-\frac{t_{1}v^{w}}{i})
\]
\[
{\implies}R-Rv^{n}-Rv^{n+w}t_{2}+Rv^{n+w}t_{2}>C(1-v^{n})(\frac{1}{i^{(p)}}-\frac{t_{1}v^{w}}{i})
\]
\[
{\implies}R>C(\frac{1}{i^{(p)}}-\frac{t_{1}v^{w}}{i})
\]
Sooooo... is the original version of the capital gains test just an approximation in this question? I guess there's only a small margin of capital gain that would fail one test but pass the other.
.
.
.
Sorry about the length, I just really like LATEX.