Exclusion ratio
Exclusion ratio is part of investor's return that is not subject to taxes. In most countries investments are taxed. But not all the return from investment is the subject to taxes. Usually the payback of initial investment is excluded and tax applies only to capital gains. Based on that exclusion ratio can be calculated as percentage of whole return.
If the investor receives annual payment from his investment, the received sum can consist of two parts: return of principal and earnings. The first part is not taxed, while the second usually is.
The formula to calculate exclusion ratio is simple:
\(ER = \frac{I}{R}\)
where:
- ER - exclusion ratio
- I - investment in a contract
- R - expected return
Exclusion ratio shows the efficiency of the investment and therefore can be important performance measure for investor.
References
- Basu, S. (1977). Investment performance of common stocks in relation to their price earnings ratios: A test of the efficient market hypothesis. The journal of Finance, 32(3), 663-682.
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