Each Bond in the Table Has a Face Value of |

question 51

Multiple Choice

$$\begin{array} { | c | c | c | c | c | } \hline \text { Bond } & \text { Coupon Rate } & \text { Maturity } & \text { Price } & \text { Yield } \\\hline \text { T-Note Strip } & 0 & 10 & 70.69 & 3.5 \% \\\hline \text { T-Bill } & 0 & 1 & 96.62 & 3.5 \% \\\hline \text { 8-year T-Note } & 5 \% & 8 & 110.31 & 3.5 \% \\\hline \text { 7-year T-Note } & 6.5 \% & 7 & 118.34 & 3.5 \% \\\hline\end{array}$$ Each bond in the table has a face value of $100. The coupon bonds pay annual coupons, and the next coupon is due in one year. Assume that the yield curve is flat and all yields are currently 3.5%. If interest rates are forecast to rise to 4% from 3.5%, what is your profit if you short-sell the bond with the biggest anticipated (percentage) decline. (Assume you short-sell only one bond.)

• A)-$3.13
• B)-$2.13
• C)$2.13
• D)$3.13
• E)$4.13

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Definitions:

Nonneutral Taxes

Taxes that disproportionately affect one group or type of economic activity over another, often used to influence market outcomes.

Second Best

A situation or solution that is accepted in the absence of a preferred option.

Distortionary Tax

A type of tax that causes consumers and producers to change their behavior in order to avoid paying the tax.

Tax Distortion

Describes how taxes can alter market behavior and lead to efficiency loss compared to an untaxed market.