Explain the impact on the interest rates of the following bonds in each of the events...

Explain the impact on the interest rates of the following bonds in each of the events using the

portfolio preference framework.

a.

Municipal bonds, when the tax rate falls

b. Corporate bonds, when the risk increases

c.

Government bonds, when the credit rating is downgraded

Expert Solution

Municipal bonds are bonds issued by local governments, such as cities states or other local governments. These bonds are tax free and carry lower interest rates.

Since they are tax free, relaxation in tax rates is going to have no effect on these kind of bonds.

Corporate bond is an instrument issued by corporations to investors. It involves a number of risks with it. But also provides higher interest rates.

When the risk increases in that case, the risk averse investors will not prefer to invest in these bonds. So investment in these bonds will decline.

Government bonds are the securities issued by the central or national government. These are considered the safest because they are backed by the government. The central government issues it in order to finance its expenditures.

In case credit ratings is downgraded the price of bonds will fall, though lower ratings mean high risk of default but also provides higher yield.

Rahul Sunny answered 2 years ago

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