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Creating a synthetic after-tax zero-coupon bond using US Treasury STRIP bonds: implications for the true after-tax spot rate

  • Phillip Daves
  • Michael Ehrhardt
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    For an individual or company that is subject to taxes, we develop a method that uses laddered Separate Trading of Registered Interest and Principal (STRIP) bonds to determine the value (and composition) of a portfolio that replicates a risk-free after-tax cash flow that will occur on a single future date. In contrast to previous approaches, our method does not require rebalancing or short sales. In addition, we show that the standard after-tax risk-free spot rate, defined as the after-tax yield on a US Treasury STRIP bond, is correct only for a flat-term structure. Using our method, we provide a true measure of the after-tax risk-free spot rate that applies to any term structure.

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    Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

    Volume (Year): 21 (2011)
    Issue (Month): 10 ()
    Pages: 695-705

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    Handle: RePEc:taf:apfiec:v:21:y:2011:i:10:p:695-705
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    1. Bierwag, G. O., 1977. "Immunization, Duration, and the Term Structure of Interest Rates," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(05), pages 725-742, December.
    2. Prisman, Eliezer Z. & Tian, Yisong, 1994. "Immunization in Markets with Tax-Clientele Effects: Evidence from the Canadian Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(02), pages 301-321, June.
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