Yields on Redeemable Securities subject to Capital Gains Tax

Extract

The imposition of a tax on capital gains invites enquiry into the effect on yields of redeemable fixed-interest securities purchased below their redemption prices. Attention has hitherto been focused on two yields in connexion with such securities, namely the yield ignoring tax, and the yield (net, or ‘grossed-up’) allowing for tax on interest payments but not on the capital gain at redemption date. Henceforth a third yield must also be considered, namely the yield (again net or ‘grossed-up’) allowing for tax on both the interest payments and the capital gain. The object of this note is to demonstrate certain relationships between these three yields, where the rate of tax payable on interest payments is assumed to be the same as that payable on the capital gain; otherwise the concept of a grossed-up net yield becomes ambiguous, if not meaningless.