Explanation:
CAPM is based on the assumption that assets are not subject to taxation. However, when tax is levied on the assets the expected return is less than that predicted by CAPM. Hence, the observed return of stock X will be less than the CAPM predicted return.
Further Breakdown:
To hold Stock X, which is affected by taxes, individuals will require a higher return. For example, investors will require a 13.33% return on Stock X so that, after taxes, they will be getting the same 10% return as on a similar-beta stock.
Ultimate access to all questions.
Stock X is subjected to a capital gain tax of 25%. What’s the most likely effect of taxes on stock X?
A
The observed return of the stock will be as predicted by CAPM.
B
The observed return of the stock will be more than that predicted by CAPM.
C
The observed return of the stock will be less than that predicted by CAPM.
D
None of the above.
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