Lets say you want to save $ 2000 today for retirement in 40 years. Assuming the Inland revenue department provides you the two options:

OPTION 1

Pay no taxes today, put the money in an interest yielding account and pay taxes equal to 25% of the total amount withdrawn at retirement.

OPTION 2

Pay taxes equivalent to 20% of the investment amount today, put the remainder in an interest-yielding account and pay no taxes when you withdraw your funds at retirement.

1. What is the expected present discounted value of each of these plans if the interest rate is 1%? 10%?

2. Explain which plan would you choose in each case and why? (detailed answer please)

3. Now, suppose individuals expect an increase in future taxes. Analyse what effect this expected increase in future taxes will have on the yield curve and on stock prices in the current period. (Detailed answer please)