1. Assume that a 26-week T-Bill is being offered at a 1.27% discount rate. Based on a $100,000 par value, what would be the initial price of this bill and how much interest would you earn over the 26 weeks? What would be the Effective Yield on this bill? Why is the effective yield different form the discount yield? Now assume that you sell the T-Bill at a current market discount rate of 1.65% after owning it for 15 weeks. What actual rate of return, on an annual basis, did you earn over the 15-week period?
2. A Treasury STRIP with 20 years remaining until maturity and a par value of $100,000 is being quoted at a yield of 2.65%. What would the current market price of this bond? What would be the price 5 years from now if interest rates have increased to 4.50%?
3. If you are in the 35% tax bracket, would you prefer to invest in a municipal bond with a yield of 3.80% or a corporate bond with a yield of 4.72%. Explain. Also explain what the relationship between municipal bond yields and taxable bond yields is and why we see that. You may assume equal risk.