The Nominal Interest Rate on Taxable Bonds Is 8%,while on Municipal

question 53

Essay

The nominal interest rate on taxable bonds is 8%,while on municipal bonds (which aren't taxable)it is 5%.The expected inflation rate is 3% and the tax rate on interest income is 40%.Calculate the expected after-tax real interest rate on both bonds.Which would be the better investment? Now suppose the actual inflation rate turned out to be 6%.Which bond was the better investment? Would your answer change if inflation had turned out to be 0%?

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Definitions:

Risk Premium

The extra return expected by investors for holding a risky asset over a risk-free one, serving as compensation for the additional risk.

Utils

A hypothetical unit of measurement used to quantify satisfaction or happiness derived from consuming goods or services.

Outcomes

The results or consequences of actions taken in a particular situation, often used in the context of strategies or experiments.

Utility Function

A mathematical representation that describes how the total utility or satisfaction a consumer derives from consuming goods and services depends on the quantities consumed.