tax before inflation or after

CFA Level III Fixed Income
#1

Hi all

I always thought that inflation should be added first to the real after tax return and then calculate the taxes.

This is logical as i will pay taxes to the full amount of my return and not after the inflation is taken out

(so if have 10% return and 30% taxes i will end up with 7% and then set aside say 3% for inflation to protect the real value of my assets. What i am left is 4% to spend)

Now in Schweser 2013 mock exam volume 2, exam 2, AM session, question 6 is calculating inflation after the tax

in that case using my example above from the 10% gain i will set aside 3% for inflation and then tax the 7% left. but when i get return of 10% the goverment is not letng yu to take out the inflation but it will tax you on the full return. Right?

either this is error from their side or i am missing smthg

pls advise

#2

I´ve seen a lot of questioning about this. To put in plain language: the BEST answer is always including taxes AFTER the inflation. So, again, TAXES is the LAST thing to include in order to bring a nominal before-tax tax return requirement.

I think in the old CFAI books they´ve used to do the other way, which is conceptually worse (but not necessarily wrong, depending on your understanding…).

#3

Exactly, I agree

So we should not do as it was in the answer of the 2013 mock schweser. They have put inflation last resulting lower required rate of return

#4

Schweser posted errata on this thank God

#5

This isn’t true.

The best answer is to _ read the vignette _; it’ll tell you whether inflation is taxed or not.

For example:

http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91321571