Question: The following data on investment yields-to-maturity (YTM) has been collected by an investor:

Security YTM

3 month T Bill 1.78%

20-year Treasury Bond 4.00%

20-year Aaa Corporate Bond 6.13%

20-year Aaa Municipal Bond 4.60%

20-year Baa Corporate Bond 7.91%

1. What is the indifference tax bracket for municipal and corporate bonds implied by this data? Will an investor in a marginal tax bracket of 20% prefer the municipal bond or the equivalent risk corporate bond? Why?
2. How much of the yield spread between the Aaa Corporate Bond and the T Bill is due to: 1) default risk 2) interest rate risk?

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