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How to determine whether to apply capital gains tax if the assumptions of makeham's formula are violated

+2 votes
asked Oct 1, 2016 in BUS 2016H - Financial Mathematics by patrick_ziet (290 points)



For this question I am having a bit of trouble with capital gains tax (CGT). Since the assumptions of Makeham's are violated we can't use the quick CGT test, I'm assuming. So would the correct way of doing things be to calculate the price assuming there is no CGT and then if that price compared with the redeemed amount implies a capital gain we would do the calculations again with CGT. Otherwise if there isn't a capital gain then that is the answer ? 

commented Oct 1, 2016 by patrick_ziet (290 points)

Or would you split the cashflows into three parts?

  1. t=0 -> t=10
  2. t=10 -> t=15
  3. t=15 -> t=30
an then treat them as three different bonds ?

1 Answer

+1 vote
answered Oct 14, 2016 by asilmotala (2,610 points)
selected Oct 24, 2016 by patrick_ziet
Best answer

Your approach certainly would work well. Often in cases like this, since a capital gains tax rate is provided CGT is often assumed, however it is better to check that there actually is a capital gains as you suggested.

As for the actual calculations of the price (first ignoring capital gains and then including capital gains), it would be best to consider them as there separate bonds for the time periods you stipulated and then add the final prices together. The only other method I can think of would be to calculate the price from a first principles approach, which would be cumbersome.