Question

Suppose your foreign government, threatened with bankruptcy, decided to tax the interest income on its own bonds as part of an effort to rectify serious budgetary woes. What would you expect to see happen to the yields on these bonds?

a. You would expect the yields to rise due to increased default risk.
b. You would expect the yields to fell due to decreased default risk.
c. You would expect the yields to rise to compensate investors for the loss of the tax-exempt status.
d. You would expect the yields to fell due to increased default risk.

Answer 1

a. You would expect the yields to rise due to increased default risk.

c. You would expect the yields to rise to compensate investors for the loss of the tax-exempt status.

Step-by-step explanation:

The foreign government is threatened with bankruptcy which means that the government might be unable to pay their bond obligations. This means that the risk of default has now increased and so yields will rise as a result of this.

Tax exempt bonds like Municipal bonds generally have lower yields because of their tax savings. If the Government was to impose taxes on previously tax exempt bonds, people would be getting less and so would have to be compensated for this loss by increased yields.