Week 4:
1. Suppose a municipal bond is paying an interest rate (yield to maturity) of 5.25%, while a corporate bond is paying an interest rate of 5.60%. Assuming these two bonds are otherwise identical (same level of risk, etc.), at what tax rate would an investor be indifferent between purchasing one bond or the other? Suppose the tax rate is actually 5%. Which bond would an investor rather purchase?
2. Price a bond that matures in two years with face value of $1000 and coupon rate of 7% if the real interest rate is 3% and inflation is expected to be 2% for the first year of the bond's life and 3% for the second year of the bond's life.
3. Let the spread (ask price minus bid price) on a 90-day Treasury bill be $0.0023 on a certain date. If the asked yield on this T-bill is 3.84% (a discount yield on an annualized basis), what must the bid yield be on that date? Use the approximation 1 year = 360 days.