As an investor, you plan to invest your funds in long - term bonds. You have $100,000 to invest. You may purchase highly rated municipal bonds at par with a coupon rate of 6 percent; you have a cho ice of a maturity of 10 years or 20 years. Alternatively, you could purchase highly rated corporate bonds at par with a coupon rate of 8 percent; these bonds also are offered with maturities of 10 years or 20 years. You expect that you will not need the fu nds for five years. At the end of the fifth year, you will definitely sell the bonds since you will need to make a large purchase at that time.
a) What is the annual interest you would earn (before taxes) on the municipal bond? On the corporate bond?
b) Assume that you are in the 20 percent tax bracket. If the level of credit risk and the liquidity for the municipal and corporate bonds are the same, would you invest in the municipal bond or the corporate bond? Why?
c) Assume that you expect all yields paid on newly issued notes and bonds (regardless of maturity) to decrease by a total of 4 percentage points over the next two years, and to increase by a total of 2 percentage points over the following three years. Would you select the 10 - year maturity or the 20 - year m aturity for the type of bond you plan to purchase? Why?