The Relationship Between Before-And After-Tax Yields On Fin

An analysis using common stocks and bonds indicates that the traditional relationship between beforetax and aftertax yields is generally incorrect and holds true only in a few special cases. The traditional relationship holds for one-year assets and perpetuities when there is only a single tax rate....

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Bibliographic Details
Published inThe Financial review (Buffalo, N.Y.) Vol. 23; no. 3; p. 313
Main Authors Bey, Roger P, Collins, J Markham
Format Journal Article
LanguageEnglish
Published Knoxville Blackwell Publishing Ltd 01.08.1988
Subjects
Bonds
Mathematical analysis
Securities analysis
Stocks
Tax rates
Yield
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Summary:An analysis using common stocks and bonds indicates that the traditional relationship between beforetax and aftertax yields is generally incorrect and holds true only in a few special cases. The traditional relationship holds for one-year assets and perpetuities when there is only a single tax rate. Otherwise, using the traditional estimate can cause significant mispricing of assets. The correct relationship between the yields is much more complex for other multiperiod assets. In those cases, the relationship is a function of: 1. the statutory tax rates on ordinary income and long-term capital gains, 2. the holding period, 3. the growth rate of common stock dividends, and 4. any premium or discount on bonds. The traditional estimate overestimates beforetax yields for both common stocks and discount bonds and underestimates beforetax yields for premium bonds. An analysis of the 1986 Tax Reform Act indicates that the Act has an effect on both common stock and bond prices but that no generalizations can be made about the magnitude or direction of the price changes.
ISSN:0732-8516
1540-6288