Question
A one-year municipal discount bond and a one-year Treasury bond have both a face value of $11,130.00. The interest rate on the treasury bond is
A one-year municipal discount bond and a one-year Treasury bond have both a face value of $11,130.00. The interest rate on the treasury bond is 0.08. The average income tax rate faced by bond market participants is 25 percent. Find the following:
a. interest rate on municipal bond
b. price of municipal bond
c. price of treasury bond
Suppose that the income tax rate increases to 50 percent, making treasury bonds less attractive. People start selling their treasury bonds to buy municipal bonds. This arbitrage causes the interest rate on treasury bonds to increase to 10 percent. Find the following after the increase in tax rate:
d. Interest rate on municipal bond
e. Price of municipal bond
f. price of treasury bond
Please include formulas and calculations.
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