Question
On May 15, 2020, 10-year pure discount bonds (maturing May 2030) issued by the US Treasury with a $100,000 face value were trading with an
On May 15, 2020, 10-year pure discount bonds (maturing May 2030) issued by the US Treasury with a $100,000 face value were trading with an annual yield of 0.625%. Assume the market placed a zero percent probability on the likelihood of default.
Question: In 2020, you were advising an investor who was contemplating between investing in this Treasury bond and a default-free municipal bond that is also a pure discount bond (recall that municipal bonds have zero tax liability on the interest). Assume that the taxes you would pay on the Treasury bond interest would entirely be paid at maturity in 2030 at a 36% marginal rate. At what annual rate of return on the municipal bond would the investor have been indifferent between the two bonds?
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