On September 1, 5 year pure discount bonds issued by the US Treasury with a $200,000 face value were trading with an annual yield of 4.47%. Assume the market places a zero percent probability on the likelihood of default.
 

At what price were the pure discount bonds trading in the market? 

 

You are advising an investor who is contemplating between investing in this Treasury bondand 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 2028 at a 38% marginal rate. At what annual rate of return on the municipal bond would the investor be indifferent
between the two bonds?

 

Alternatively, the investor could place the money in a certificate of deposit (CD) that makes interest payments monthly. Taxes on those interest payments would also be paid monthly out of the CD account.

 If that were the case, what interest rate would the bank have to offer to make you indifferent between the three choices? Again assume that there is zero chance of default.