Answer the following questions about capital gains taxes:

(a) Suppose there is a 50% chance that an investment of $10,000 will rise in value to $12,500, and a 50% chance that the investment will fall in value to $7,500. In addition, the government has imposes a 50% tax on capital gains and allows a deduction against taxable income for any losses (assume that the tax rate is 50%). What is the expected return on the investment? (4 points)

(b) Re-answer part (a), but now assume that the government decides to eliminate tax loss offsets. (3 points)

(c) What your answers in parts (a) and (b) suggest the elimination of tax loss offsets? Would the elimination encourage MORE or LESS risk taking among investors? Explain.

(d) Re-answer part (a), but now assume that the capital gains tax rate is lowered from 50% to 25%.

(e) What your answers in parts (a) and (d) suggest the lowering of capital gains tax rates? Would the tax cut encourage MORE or LESS risk taking among investors? Explain.