CFA Level 3 | PWM: After-tax Post-Liquidation Return

[@anubhav167]

Thanks Fabian. After so many months, a new video came through. Looking forward to more of your videos.

[@FabianMoa]

You're welcome, Anubhav. Yes, it has been quite a while since my last post. Hoping to get more videos posted consistently.

[@corea12822]

I have the exam in 3 days and I’m definitely gonna go over all your videos tomorrow 👍 i passed my level 2 exams thanks to your videos. You are a life saver😂 thank you so much Fabian

[@FabianMoa]

I wish you all the best in your exams!

[@shubhamkhaitan]

Two days for my CFA L2 exam and this video came out of the blue and absolutely cleared my concept of Derivative equivalencies with the simple application of PCP. Thank you very much!

[@FabianMoa]

Glad it helped!

[@hh7012]

Thank you so much, Fabian. I find your CFA Level 3 video is very helpful! :)

[@zzzzzzzzhe]

Hi Fabian, thanks for your clear explanation and pointing out the errata for 2023 curriculum. I am looking at 2024 curriculum, and it is still showing the old formula (as the one in 2023 before errata, subtracting liquidation tax/final value, instead of using *(1-liquidation tax/final value). There is no update in 2024 errata about this. Do you think CFA has changed back to the old formula in 2024, or shall we wait for the 2024 errata to be updated? Thanks!

[@FabianMoa]

Thanks for the feedback! It's surprising that the 2024 errata doesn't contain it but I would stick to the 2023 errata (the right formula)

[@leonard04123]

Hi Fabian, Firstly thanks for the awesome material. Whenever I am in doubt I come to your channel to seek wisdom. However I am experiencing some slight confusion on the 2 cases you shown. First case treats the 3 years returns as after tax returns however the 2nd case treats them as pre-tax returns? Or am I missing something entirely here. Appreciate it if anyone can help shed some light as well! Exam in 10 days

[@FabianMoa]

Hi Leonard, can you elaborate more on how the 2nd case treats them as pre-tax returns. The method in both cases except for how the capital gains are calculated. Everything else is the same.

[@leonard04123]

⁠@@FabianMoa Haha I assume I am missing something. Thanks for the fast response. in the 2nd case the 16.8% is taxed at 25%. Resulting in a post tax return of 12.6% annualized to 4.044%. However in the first case the 16.8% isn’t taxed.

[@FabianMoa]

I see. For the 2nd case, the capital gains is 0.168 (=1.168 - 1). For the 1st case, the capital gains is 0.1168 (= 10% × 1.168). In both cases, the gains would be taxed at 25%. So I am not treating them like pre-tax returns.

[@leonard04123]

@@FabianMoa oh! Ok I will rewatch and digest with that in mind. Thanks so much for elaborating. I think my gap is the understanding of embedded capital gains. Much appreciated

[@leonard04123]

@@FabianMoa ​ Ok post digesting I think i know where is root cause of my error is. Comparing both cases I would have thought that the case with embedded capital gains tax would have a lower post liquidation return v.s the one where tax basis is zero. The Taxable amount for case 1 is only 10% of the final value at a 25% rate. 1 outstanding question I have is why is the 16.8 returns% not taxed at 25% for the first example? E.g 1 where Embedded capital gains taxable is 10% of final value Therefore Final value = 1.168 (This is where i am confused) Tax = 1.168*0.1*0.25= 0.0292 Returns post tax = 1.168*(1-0.0292)=1.1388 Annualized = 4.4444% E.g 2 where Tax basis of 1 Tax = (1.16844-1)*0.25=0.04211 Returns post tax = 1.168-0.04211=1.12589 Annualized = 4.045% My calculation for case 1. Portfolio has 10% embedded capital gains untaxed. Tax = ((1.168*1.1)-1)*0.25=0.0712 Returns post tax = ((1.1*1.168)-0.0712)/1.1=1.10327 Annualized =3.3333% In dollar terms. I started with 110 dollars (10 dollars capital gains unpaid in tax). Post 3 years returns I now have 110*1.168 =$128.48. Tax payable = 28.48*0.25=7.12 dollars Port after tax = 128.48-7.12=121.36 Return = 121.36/110 = 10.327% Annualized 3.3333% Many thanks for clarifying! Appreciate the time and if it sounds like a silly clarification please do let me know

[@pavanpurohit2539]

Would it be possible for you to please explain how these formula are derived?

[@FabianMoa]

The liquidation tax/final value is expressed as a tax rate on the capital gains. Final value x (1 - Liquidation tax/Final value) = Final value - Liquidation tax

[@vrittib8818]

thanks a lot!

[@pavanpurohit2539]

Hi thanks for this. However, your solution differs from the cfa text. Please check the solution for reading 22 practice problem 6 (CFA level 3).

[@FabianMoa]

Hi Pavan, Do check out CFAI's errata (Page 2) on the correction to the formula. www.google.com/url?sa=t&source=web&rct=j&opi=89978449&url=www.cfainstitute.org/-/media/documents/support/programs/cfa/2023-cfa-level-iii-errata.pdf&ved=2ahUKEwi3n8z3rvqAAxUVbvUHHW0_D5AQFnoECBsQAQ&usg=AOvVaw0nAiAmp_VeSj_InUJB43P-

[@pavanpurohit2539]

Thank you