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1) Suppose that a corporate bond with a Baa credit rating and five years to maturity has a yield to maturity of 8 percent. Suppose

1) Suppose that a corporate bond with a Baa credit rating and five years to maturity has a yield to maturity of 8 percent. Suppose that the government of the city of Udwellum, which has a Baa credit rating, issues a bond with the same time to maturity in a market that is just as liquid as the market for corporate bonds. Suppose that investors have a federal tax rate of 30 percent. Calculate the interest that Udwellum should pay on its bonds if they they would yield the same after-tax rate of return to investors as comparable corporate bonds. Show workings.

2) You are given the following information on the bond market:

Money available on January 1, 2013: $1,000 Interest rates on January 1, 2013, on bonds of different maturities: one year, 4 percent; two years, 5 percent; three years, 5.5 percent; four years, 6 percent Note: Consider these to be bonds that compound the interest at the rate given, that is, the three-year bond pays $1,000 * 1.0553

at maturity.

Expected future interest rates on one-year bonds: January 1, 2014: 6.5 percent January 1, 2015: 7 percent January 1, 2016: 9 percent Investment horizon: four years, ending January 1, 2017 What should an investor buy to yield the largest stream of expected income over the period from January 1, 2013, to January 1, 2017?

3) How would your answer to question 2 change if there is a $10 transactions cost for every bond purchased? In other words, if an investor has $1,000 now, she can spend only $990 on a bond because $10 goes for transactions costs. Each time she buys a new bond, she incurs the $10 fee.

4) If the newspaper reported that the interest rate on 10-year Treasury securities was 5 percent and the interest rate on three-month Treasury securities was 6 percent, would it be a good time to invest in the stock market? Explain your reasoning.

5)Consider the following four debt securities, which are identical in every characteristic except as noted:

W: A corporate bond rated Aaa

X: A corporate bond rate Baa

Y: A corporate bond rated Aaa with a shorter time to maturity than bonds W and X

Z: A corporate bond rated Aaa with the same time to maturity as bond Y that trades in a more liquid market than bonds W, X, or Y.

List the bonds in the most likely order of the interest rates (yields to maturity) of the bonds from highest to lowest. Explain work.

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Answer 1 To calculate the interest that Udwellum should pay on its bonds to yield the same aftertax rate of return as comparable corporate bonds we need to consider the tax implications for investors ... blur-text-image

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