Question

Suppose​ that, holding yield​ constant, investors are indifferent as to whether they hold bonds issued by the federal government or bonds issued by state and local governments​ (that is, they consider the bonds the same with respect to default​ risk, information​ costs, and​ liquidity). Suppose that state governments have issued perpetuities​ (or consoles) with ​$85 coupons and that the federal government has also issued perpetuities with ​$85 coupons. If the state and federal perpetuities both have​ after-tax yields of 7​%, what are their​ pre-tax yields?​ (Assume that the relevant federal income tax rate is 36.2936.29​%.)

The​ pre-tax yield on the state perpetuity will be

The​ pre-tax yield on the federal perpetuity will be

Answer 1

Hence,

# - The pre-tax yeild on the state perpetuity will be 7%.

#- The pre-tax yeild on the federal perpetuity will be 10.98%.

Thankyou

Please rate thumbs up.