Question $8$

$5$ pts

Following the $2017$ U$.$S$.$ tax reform that reduced the top marginal income tax rate from $39\mathrm{.}6\%$ to $37\%,$ consider the behavior of two inwestors$-$Investor A $($a high$-$income individua$)$ and Investor B $($a tax$-$exempt institution$)$ Prior to the reform, both Invested equatly in municipal and Treasury bonds. Assume no change in default risk or liquidity in either market.

Using the supply and demand framework for bonds, and considering the tax treatment of municipal vs$.$ Treasury bond interest, which of the following outcomes is most consistent with the new equilbrium after the taxcut?

Investor A reallocates toward municipal bonds, increasing their demand, which lowern municigal yields relative to Treasury vields; Ifreestor B is unsiffected due to tax exemption.

Irvestor Arealiocabes towaed Treasury bondh, decreaning munidipal bond demund, which raises municipal yelds relative to Treasury vields; Investor $10$ aho reallocates toward Treawry bonds due to superior tax$-$aduated rethims.

Inventor A reallocanes towand Trearwry bonds, decreanint municioal bond dorund, which rabes municipur yiekh relative to Treasury yiclds: Imvestor B does not ch inge alocation but muricoul bond prices isal fall due to aceregate demand effects.

affect after$-$tac returns sigelificantly, yields remain unctanpod.