Question

Suppose that the Federal government decides to reduce the tax advantage of municipal bonds, relative to US Treasury bonds. In this case, we would expect that the equilibrium yield in the municipal bond market will ____ and the yield in the US Treasury bonds market will ____.

A) fall; rise

B) fall; fall

C) rise; rise

D) rise; fall

Answer 1

Suppose that the Federal government decides to reduce the tax advantage of municipal bonds, relative to US Treasury bonds. In this case, we would expect that the equilibrium yield in the municipal bond market will fall and the yield in the US Treasury bonds market will rise.

Therefore the correct option is:

• (A.) fall; rise

Explanation

When the Federal government decides to reduce the tax advantage of municipal bonds, relative to US Treasury bonds, the demand for municipal bonds declines and demand for US Treasury bonds Increases. Which results in reduction of equilibrium yield in the municipal bond market. On other hand, Increased demand for US Treasury bonds, lead to increase the yield in the US Treasury bonds market. Therefore, we would expect that the equilibrium yield in the municipal bond market will fall and the yield in the US Treasury bonds market will rise