CFAI 2013 AM Q1 D

CFA Level III
#1

I’m having trouble with how the CFA treats taxation on inflation. in an IPS return calculation, inflation is assumed to be a deferred capital gain and therefore not taxed, correct? (If they plan on preserving their purchasing power).

In the question referenced above, the inflation is taxed… even when this question is referring to the Voorts family who have expressed that they want to preserve their wealth (I.E the inflation component is not realized, but added to the account every year).

In my mind, inlfation should only be taxed in an expected return calculation if you realize all gains every year and then reinvest. This is very frustrating to me and I would very much appreciate some help here.

#2

yep, this is confusing. Mr S2000 has an article on his website that links explains this concept…and unfortunately I can’t remember the answer.

#3

Do you happen to have a link?

#4

Ver helpful article

http://financialexamhelp123.com/inflation-in-required-rate-of-return-to-tax-or-not-to-tax/

#5

Thanks to both of you (and S2000). Glad to get some clarity here.

For others who might stumble on this thread, the answer is the inflation is taxed.

#6

The default seems to be increase for taxes and then add inflation as opposed to add inflation then increase for taxes

#7

if you are doing it all multiplicative, it shouldnt matter

#8

Wait so if the real return is 5% for example, and tax rate is 30%, and inflation rate is 3%, then you do: .05/(1-.30)+.03 Correct?

#9

Nope. It is (1.05 x 1.03 -1)/1-0.3

#10

correct

#11

Add return with inflation (or multiply), then divide by (1-T).

Correct. Per either the 2013/2014 AM on CFA site.

INcorrect. Per either the 2013/2014 AM on CFA site.