Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz.com CFA Level III Item-set - Question Study Session June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz Item-set ID: 12499 Questions 1(12493) through 6(12498) relate to Reading 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 $65,000 on the portfolio at the end of this year Exhibit Tax Structure on Ordinary Income Taxable Income ($) Tax on Column Percentage on Excess Over Column Over Up to 15,000 - 27 15,000 25,000 4,050 34 25,000 37,000 7,450 39 37,000 45,000 12,130 44 45,000 70,000 15,650 46 27,150 50 70,000 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 $200,000 portfolio that is purely invested in TDAs and TEAs The TDA account is invested in fixed income securities whereas the TEA account is invested in equities The pretax market values and weights of these accounts are highlighted below Withdrawals from the TDA account are taxed at a rate of 40% FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com Exhibit TDA and TEA Account Holdings Account Type Pre-tax Market Value ($) Pre-Tax Market Weights (%) TDA 60,000 30% Tax-Exempt 140,000 70% 200,000 100% Total Portfolio FinQuiz Question ID: 12500 At the end of the year, the marginal tax rate earned on Larson’s portfolio would be closest to: A 21% B 44% C 46% FinQuiz Question ID: 12501 At year end, the average tax rate earned on Larson’s portfolio would be closest to: A 21% B 38% C 46% FinQuiz Question ID: 12502 Using the proportions invested in investment income and their associated tax rates (exhibit 1), the future value of Larson’s portfolio in twenty years time is closest to: A $882,000 B $1,770,000 C $1,780,000 FinQuiz Question ID: 12503 The accrual equivalent after-tax return earned on Larson’s portfolio is closest to: A 2.88% B 6.52% C 6.55% FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz Question ID: 12504 The after-tax weights for equities and fixed income allocations, invested in the TDA and TEA accounts, respectively are: A 20%; 80% B 30%; 70% C 42%; 58% FinQuiz Question ID: 12505 Assuming Larson were living in a country which operates with a progressive tax rate 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: A Heavy interest tax regime B Common progressive tax regime C Light capital gain tax regime FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz Item-set ID: 11238 Questions 7(11239) through 12(11244) relate to Reading 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: Account Asset Class Pre-tax market value TDA Bonds $170,000 Tax-exempt Stocks $70,000 Total $240,000 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.” Statement 2: “If the efficient frontier of portfolios is viewed on an after-tax basis, the same asset could appear on the efficient frontier in both taxable and non-taxable form.” Smith agreed with Anderson’s first statement but disagreed with his second statement FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz Question ID: 11239 Anderson’s estimate of effective capital gains tax rate for Harris’ portfolio is closest to: A 2.78% B 3.19% C 5.78% FinQuiz Question ID: 11240 If Harris’ portfolio has an expected value of $1,503,400, Anderson’s estimate of return after realized taxes will be closest to: A 11.5% B 12.0% C 12.5% FinQuiz Question ID: 11241 Which of the following tax regimes is least likely to have the favorable treatment for interest income? A Heavy dividend tax regime B Light capital gain tax regime C Flat and heavy regime FinQuiz Question ID: 11242 10 Which of the following most accurately characterizes the statements made by Anderson? A Statement is correct but statement is incorrect B Statement is correct but statement is incorrect C Both statements are correct FinQuiz Question ID: 11243 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? A 22.5% B 27.5% C 30.0% FinQuiz Question ID: 11244 12 With regard to his response to Anderson’s statements, Smith is least likely correct with respect to: A statement only B both of the statements C none of the statements FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz Item-set ID: 19035 Questions 13(19036) through 18(19041) relate to Reading 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 time Comment 2: The relative value accumulation is unaffected by risk-adjusted returns generated on assets taxed in an annual taxation environment FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com 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 Information and Projection Concerning Jones’ Portfolio, as of 2010: Portfolio’s percentage price increase, realized as + 25% capital gains Capital gain tax rate 30% Securities with unrealized capital loss: Current cost basis A$100,000 Current market value A$70,000 Forecasted percentage price change in 2011 + 30% Exhibit Pre-Tax Asset Allocation of Lane’s Portfolio Existing Pre-tax Asset Allocation Account Class Account Type (%) Bonds TDA 60 Stock Tax-exempt 40 100 Exhibit Progressive Tax Rate Schedule Taxable Income (A$) Tax on Income – 6,000 6,001 – 37,000 15c for each A$1 over A$6,000 37,001 – 80,000 A$4,650 plus 30c for each A$1 over A$37,000 80,001 – 180,000 A$17,550 plus 37c for each A$1 over A$80,000 180,001 and over A$54,550 plus 45c for each A$1 over A$180,000 FinQuiz.com © 2018 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz.com FinQuiz Question ID: 19036 13 Using the information provided on Jones’ portfolio and Exhibit 1, the tax savings generated by Schultz’s proposed strategy are closest to: A A$9,000 B A$103,500 C A$328,500 FinQuiz Question ID:19037 14 Which of the following limitation is most likely associated with the strategy recommended by Schultz for Jones’ portfolio? A The strategy is less valuable during high volatility periods B Cumulative tax alphas will decrease with the passage of time C The strategy is unprofitable when tax rates are forecasted to increase FinQuiz Question ID:19038 15 Using the information provided with respect to Lane’s portfolio and Exhibit 2, the after-tax asset allocation is most likely: A 36.0% bonds; 64.0% stock B 40.0% bonds; 60.0% stock C 47.4% bonds; 52.6% stock FinQuiz Question ID:19039 16 With respect to Po’s portfolio, the relative value of the accumulation calculated by Shultz is closest to: A 0.912 B 1.097 C 2.959 FinQuiz Question ID:19040 17 With respect to the comments made, Shultz is least likely correct with respect to: A comment only B comment only C both of the comments FinQuiz Question ID:19041 18 Using the information in Exhibit 3, Russell’s marginal tax rate exceeds his average tax rate by: A 8.03% B 1.53% C 6.07% FinQuiz.com © 2018 - All rights reserved .. .Reading Taxes and Private Wealth Management in a Global Context FinQuiz. com FinQuiz Item- set ID: 124 99 Questions 1( 124 93 ) through 6( 124 98 ) relate to Reading Heather Larson... regime FinQuiz. com © 20 18 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz. com FinQuiz Item- set ID: 11 23 8 Questions 7(11 23 9 ) through 12( 1 124 4) relate... statements FinQuiz. com © 20 18 - All rights reserved Reading Taxes and Private Wealth Management in a Global Context FinQuiz. com FinQuiz Item- set ID: 19 035 Questions 13( 19 036 ) through 18( 190 41) relate