1) True of False? \"If Congress changes the tax law to increase marginal tax rat

Question

1) True of False?

"If Congress changes the tax law to increase marginal tax rates, the price of municipal bonds will increase."

2) There are several mortgage risks. This is a unique risk for mortgages that you cannot observe for other types of securities. Mortgage investors are usually forced to reinvest at a lower interest rate due to this risk. What is this risk?

3) "The equivalent taxable yield is higher than the muni yield if the muni is state and federal income tax exempt." Is this statement true?

Explanation / Answer

1. Answer is True : an increase in tax rates will increase the attractiveness of municipal securities. An increase in tax rates will have positive impact on the price of the municipal bonds as demand will increase. An increase in price needed to restrict the desired return.

2. On a normal mortgage , interest and principals are paid each other th causing the amount of interest earned to decrese. This is undesirable to many investors and they are forced to reinvest the pricipal. This is called " Reinvestment Risk"

3. True : when muni yield is tax exempt , the equivalent taxable yield will be always higher. You can use below formula to check this

Taxable equivalent yield = tax exempt yield / (1-Marginal tax rate )

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