Question

QUESTION 26 Which of the following statements are true? A. Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets. B. An increase in tax rates will increase the demand for municipal bonds, lowering their interest rates. C. Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption. D. All of the above are true statements. E. Only A and B are true statements

Answer 1

All three statements regarding municipal bonds and their tax-exempt status, demand in response to tax rates, and comparative interest rates to taxable bonds are true. The correct answer is that all of the above are true statements.

Step-by-step explanation:

Statement A is true. The attractiveness of municipal bonds, especially for those in higher tax brackets, is that their coupon payments are exempt from federal income tax. This exemption means that the after-tax return on municipal bonds is indeed higher for individuals who fall under higher income tax brackets, compared to investing in taxable bonds where their interest would be subject to taxation.

Statement B is also true. If tax rates increase, the exemption offered by municipal bonds becomes more valuable. This leads to an increase in the demand for such bonds. Consequently, as the demand for these bonds increases, the yield (interest rate) they need to offer to attract investors goes down.

Statement C correctly asserts that municipal bonds typically offer lower interest rates than comparable taxable bonds. This difference in rates is primarily because the tax-exemption effectively increases the after-tax return for the investor, making them willing to accept a lower interest rate than they would on a taxable bond.

The correct answer to the question is D: All of the above are true statements.

Answer 2

D

Step-by-step explanation:

A municipal bond is a debt instrument issued by a state or municipality to finance its capital expenditures.

Municipal bonds are usually exempt from federal income tax. This makes these bonds attractive to individuals with a high income tax bracket

If tax rate increases, investors would prefer to invest more in municipal bonds because it is exempt from tax. The increase in demand for these bonds would lead to decrease in its interest rate.

Due to tax exemption, the interest rate on municipal bonds is lower than on comparable bonds

Types of municipal bonds

1. General obligation bonds : these bonds are not secured by any form of asset. Instead they are backed up by the credit worthiness of the issuer.
2. Revenue bonds : these bonds are secured by revenue from a particular project. e.g. revenue from highway tolls