LOS h: Explain the relation of after-tax returns with trading behavior and capital gains recognition.

Q1. With respect to active investors and the tax structure in many countries, which of the following is the most accurate?

A)   To offset their higher taxation, active investment managers must use tax-exempt accounts.

B)   As a result of their lower taxation, active investment managers can remain in business even when they generate lower pre-tax returns.

C)   To offset their higher taxation, active investment managers must generate higher pre-tax returns.

Q2. Of traders, active investors, and passive investors, which probably forgo the most tax advantages of equity?

A)   Traders.

B)   Active investors.

C)   Passive investors.

Q3. With respect to traders and active investors, which of the following statements is the most accurate?

A)   Active investors trade more frequently than traders so that many of their gains are taxed at lower rates.

B)   Active investors trade as frequently as traders but they use strategies that lead to their gains being taxed at higher rates.

C)   Active investors trade less frequently than traders so that many of their gains are taxed at lower rates.

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Q1. With respect to active investors and the tax structure in many countries, which of the following is the most accurate?

A)   To offset their higher taxation, active investment managers must use tax-exempt accounts.

B)   As a result of their lower taxation, active investment managers can remain in business even when they generate lower pre-tax returns.

C)   To offset their higher taxation, active investment managers must generate higher pre-tax returns.

Correct answer is C)

To offset their higher taxation, active investment managers must generate higher pre-tax returns. This is also true for mutual funds, especially those with high turnover, because in many countries, long-term capital gains are taxed at a lower rate and accumulate tax-free until the gains are realized.

Q2. Of traders, active investors, and passive investors, which probably forgo the most tax advantages of equity?

A)   Traders.

B)   Active investors.

C)   Passive investors.

Correct answer is A)

Traders trade the most frequently, and would forgo the tax-deferred properties of equity that is allowed to grow in value over a long period. Active investors trade less frequently than traders.

Q3. With respect to traders and active investors, which of the following statements is the most accurate?

A)   Active investors trade more frequently than traders so that many of their gains are taxed at lower rates.

B)   Active investors trade as frequently as traders but they use strategies that lead to their gains being taxed at higher rates.

C)   Active investors trade less frequently than traders so that many of their gains are taxed at lower rates.

Correct answer is C)

Traders trade more frequently. Therefore, traders generally pay higher tax rates.