Econ Q - MOCK

CFA Level I
#1

Which of the following are the most likely effects of an increase in tax on interest income on the investment demand and interest rates, respectively? Effect on investment demand Effect on interest rates A. No effect No effect B. No effect Increase C. Decrease No effect D. Decrease Increase The answer is B however wouldn’t an increase in tax leads to a decrease in AS and AD which would lead to increase IR and therefore decrease in investment demand???

#2

Oops, found the question.

#3

B

#4

B

#5

It’s not an increase on taxes in general, just interest income. Firms look at the real interest rate and how productive capital is and what it costs.

#6

Can you guys explain why it is B? S

#7

I would have thought it was D as well…can someone explail why investment Demand would not decrease as a result of a higher tax on interest income? The best reason I can come up with is that since the Supply of Money is perfectly inelastic at any one point in time, the increase in taxes on interest income will shift the demand for money to the right causing a higher interest rate at the same investment level…am I way off or is this close to the reason?

#8

The reason I gave above is what CFAi gave.

#9

In the long run it would have an effect on Investment demand right since interest rates rise?

#10

Amber, can you provide a reference so I can better understand it?

#11

try Vol. 2 pp 441-43 Study session 6-27-b I don’t have the books on me.

#12

I will take a look…thanks!

#13

“A tax on interest income has no effect on investment demand. The reason is that the quantity of investment that firms plan to undertake depends only on how productive capital is and what it costs - its real interest rate. But a tax on interest income weakens the incentive to save and decreases save and decreases saving supply. For each dollar of before tax earnings, savers must pay the government an amount determined by the tax code. So savers look at the after tax real interest rate when they decide how much saving to supply” ~ CFA pg 443

#14

Here they are talking about investment demand as in borrowing money and investing it in the company for a new product. An increase in taxes in investment interest income would not affect companies borrowing money in a sense.