Question 1

Assume that investment earnings are taxed,losses can be deducted,and the tax structure is progressive.Which statement is TRUE?

Accepted Answer

Since investment earnings are taxed and losses can be deducted, winning gambles will be taxed at a higher rate than the rate at which losing gambles are deducted. This is because the tax structure is progressive, meaning that higher income levels are subject to higher tax rates. As winning gambles count as income, they will be taxed at a higher rate for those who have already exceeded the lower income levels where losing gambles can be fully deducted. This creates a disincentive to take on risk, as the potential tax burden is higher for successful outcomes.

Question 2

Who supports the estate tax,saying that it is "…in keeping with the idea of equality of opportunity in this country"?

Accepted Answer

Warren Buffet is a well-known advocate for the estate tax, arguing that it promotes fairness and prevents the perpetuation of wealth and power in a small number of families.

Question 3

Which of the following assets CANNOT have a capital gain?

Accepted Answer

A savings account cannot have a capital gain because it is not considered an asset that appreciates in value. Capital gains refer to the profit gained from selling an asset at a higher price than what was initially paid for it. Mutual funds, artwork, and real estate are all assets that can appreciate in value and therefore, have the potential for capital gains.

Question 4

Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400,a 25% chance that the investment will remain at $1,000,and a 50% chance that the investment will fall in value to $500.The government introduces a 50% tax on returns to investment and allows a deduction against taxable income for any losses (assume that the tax rate is 50%).What is the expected return on the investment?

Accepted Answer

The expected return on the investment, considering the tax implications, can be calculated as follows:1. If the investment rises to $1,400, the gain is $400. With a 50% tax, the net gain is $200 (50% of $400). The probability of this happening is 25%, so the expected return from this outcome is 0.25 * $200 = $50.2. If the investment remains at $1,000, there is no gain or loss, so the expected return from this outcome is $0.3. If the investment falls to $500, the loss is $500. With a 50% deduction allowed against taxable income for losses, the investor can deduct $250 (50% of $500). However, since this is a deduction against taxable income rather than a tax credit, the actual monetary return to the investor is $0 because the deduction only offsets potential tax liabilities on other income, not providing a direct benefit from the investment itself. Thus, the expected return from this outcome is 0.50 * -$500 = -$250.Adding these expected returns together: $50 + $0 - $250 = -$200.However, the calculation for the loss scenario was incorrectly interpreted regarding the tax benefit. The correct approach should consider the tax deduction as a direct reduction in the loss amount, effectively halving the loss due to the 50% tax rate. Therefore, the correct calculation for the loss scenario should be:3. Corrected: If the investment falls to $500, the loss is $500. With the ability to deduct this loss, the effective loss is halved to $250 due to the 50% tax rate. The probability of this happening is 50%, so the expected return from this outcome is 0.50 * -$250 = -$125.Correcting the calculation with the proper understanding of the tax deduction on losses, the expected returns should be recalculated, leading to a different conclusion than initially presented. The correct expected return calculation would account for the tax benefits correctly, potentially altering the final answer.

Question 5

Suppose that the government taxes income and investment earnings at 25% and allows half of investment losses to be deducted from taxable income,up to a maximum of $3,000 per year.Which of the following amounts is equal to the tax loss offset for someone who lost $5,000 on investments last year?

Accepted Answer

The answer of Suppose that the government taxes income and...

Question 6

A capital gain is best defined as the:

Accepted Answer

A capital gain is the profit realized when an asset is sold for a price higher than the purchase price. It is the difference between the purchase price and sale price of an asset, such as investment property, a stock or a piece of art.

Question 7

Suppose that there is a 75% chance that an investment of $1,000 will rise in value to $1,500,and a 25% chance that the investment will fall in value to $700.What is the expected return on the investment?

Accepted Answer

The answer of Suppose that there is a 75% chance...

Question 8

The basic model of taxation and risk taking was developed by Domar and Musgrave in 1944; it reached the conclusion that:

Accepted Answer

The Domar and Musgrave model concluded that taxing the returns from risky assets will actually increase risk taking because investors seek to maintain their after-tax returns, leading them to take on more risk to compensate for the taxes paid on returns.

Question 9

Suppose a person buys a share of stock for $10.The day before the person dies,the stock is worth $20,as it is the day after the person dies.If the stock were sold the day before the person died,the basis would be ________; if the stock were sold the day after the person died,the basis would be _________,assuming earnings on assets are taxed as they are in the current U.S.system.

Accepted Answer

The answer of Suppose a person buys a share of...

Question 10

Suppose a person buys a share of stock for $10.The rate of taxation on accrual is 50% and the rate of taxation on realization is 25%.The day before the person dies,the stock is worth $20,as it is the day after the person dies.If the stock were sold the day before the person died,the government would receive ________ in taxes; if the stock were sold the day after the person died,the government would receive ________ in taxes.Assume that earnings on assets are taxed as they are in the current U.S.system.

Accepted Answer

If the stock were sold the day before the person died, the person would have to pay taxes on their earnings of $10 ($20-$10). The rate of taxation on accrual is 50%, so the taxes paid would be $5 ($10 x 50%). If the stock were sold the day after the person died, the person's cost basis would be stepped up to the current value of $20, so there would be no taxable gain. Therefore, the government would not receive any taxes on the sale. So, the total amount of taxes the government would receive is $2.50 ($5/2).

Question 11

If an individual purchases an asset and sells it before he dies,the capital gains tax burden is based on the:

Accepted Answer

Capital gains tax is calculated based on the difference between the sale price of the asset and the basis which is generally the purchase price plus any additional costs such as commissions or fees. Therefore, the correct answer would be A - sale price minus the basis.

Question 12

Suppose that the government introduces a 50% tax on returns to investment and allows a deduction against taxable income for any losses (assume that the tax rate on taxable income is also 50%).Which statement is TRUE?

Accepted Answer

Under this tax policy, if an investment loses money, the investor can deduct the loss against taxable income, effectively sharing the loss with the government at the tax rate of 50%. This means the investor bears only half the loss.

Question 13

Which of the following assets could yield a capital gain?

Accepted Answer

A house can yield a capital gain when its value increases and is sold for a higher amount than its purchase price. The other options (savings account, bank certificate of deposit, checking account) typically do not yield capital gains as they are not investments in assets that appreciate in value.

Question 14

Taxation on accrual is best defined as:

Accepted Answer

Taxation on accrual refers to the taxes paid each period based on the return earned by an asset during that period, regardless of whether or not the asset has been sold. This is in contrast to taxation on realization, where taxes are only paid when an asset is sold and the return is realized. Therefore, option C is the best definition of taxation on accrual. Options A, B, and D are not related to accrual taxation.

Question 15

Suppose that there is a 50% chance that an investment of $1,000 rises in value to $1,200,and a 50% chance that the investment falls in value to $900.What is the expected return on the investment?

Accepted Answer

To find the expected return on the investment, we need to calculate the weighted average of the possible returns, using the probabilities as weights.

Expected return = (probability of $1,200 return x $1,200) + (probability of $900 return x $900)
Expected return = (0.5 x $1,200) + (0.5 x $900) = $1,050

Therefore, the expected return on the investment is $1,050. However, since the initial investment was $1,000, the net return is $1,050 - $1,000 = $50. Therefore, the best choice is B.

Question 16

Suppose you put $10 into a savings account.A year later the account has $12 in it,all of which you withdraw.The tax rate on accrual is 50% and the tax rate on realization is 25%.How much tax on accrual do you owe? Assume that both taxation on accrual and taxation on realization apply as they do under current U.S.tax policy.

Accepted Answer

The answer of Suppose you put $10 into a savings...

Question 17

Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400,and a 75% chance that the investment will fall in value to $900.What is the expected return on the investment?

Accepted Answer

To calculate the expected return, we multiply the probability of each outcome by its return and sum them up. So,

Expected Return = (Probability of Increase x Return of Increase) + (Probability of Decrease x Return of Decrease)
Expected Return = (0.25 x $400) + (0.75 x (-$100))
Expected Return = $100 - $75 = $25

Therefore, the expected return on the investment is $25. Thus, the best choice is C.

Question 18

Assets that earn interest are taxed on _____; capital gains are taxed on _____.

Accepted Answer

Assets that earn interest are typically taxed on an accrual basis, meaning as the interest is earned it is taxed, regardless of whether it is received or not. Capital gains, on the other hand, are taxed on a realization basis, meaning they are taxed at the time the asset is sold and the gain is actually realized.

Question 19

Suppose that the government taxes any positive return on an asset and allows a full deduction of a negative return against taxable income.Which statement is TRUE under this scenario,versus one under which there are no taxes?

Accepted Answer

These tax policies increase risk taking because they effectively share the risk between the investor and the government. By allowing a full deduction of a negative return, the government reduces the downside risk for the investor, making riskier investments more attractive.

Question 20

Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400,a 25% chance that the investment will remain at $1,000,and a 50% chance that the investment will fall in value to $900.What is the expected profit associated with the investment?

Accepted Answer

The answer of Suppose that there is a 25% chance...

Quiz 23: Taxes on Risk Taking and Wealth