Question

What would happen to the risk premiums of municipal bonds if the federal government guarantees today that it will pay creditors if municipal governments default on their payments O A. Risk premium on municipal bonds will decrease O B. Risk premium on municipal bonds will stay the same. OC. Risk premium on municipal bonds will increase. OD. There is not enough information to tell. Do you think that it will then make sense for municipal bonds to be exempt from income taxes? O A. No. If this were to happen, then municipal bonds will be even better than U.S. government bonds. O B. Yes, Municipal bonds will continue to have higher risk premium than Treasury bonds and will need "help" to gain access to funds

Answer 1

- What would happen to the risk premiums of municipal bonds if the federal government guarantee today that it will pay creditors if municipal governments default on thier payments?

A risk premium for an individual is the minimum amount of return assure to get the individual which must exceed than the returen get on the risk free assets so that the individual should hold the risky assets than the risk free assets. Thus in this situation if the federal government is assuring the return on the municipal bonds, it increases its creadiblity and thus it will increase the risk premium of the individual on the cost of federal governmrnt gurantee.

Hence, Option C is correct.

(C) : Risk peemium on municipal bond will increase.

- Do you think that it will then make sense for municipal bonds to be exempt from income taces.

In this scenarion when such municipal bond gets income tax exemption then it will help the municipal bonds to get access to the fund more easily. The municipal bonds are issued generally to fund the projects of local authority and the public infrastructure. Thus if the municipal bonds are exempt from the income tax, it will continue to have higher risk premium than treasury bonds.

Hence, Option B is correct.

(B) : Yes, municipal bonds will continue to have higher risk premium than treasury bond and will need to access the fund.

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