M & B 4th Edition by Dean Croushore

Exercise 3

Suppose that a corporate bond with a Baa credit rating and fi ve years to maturity has a yield to maturity of 8 percent. Suppose that the government of the city of Udwellum, which has a Baa credit rating, issues a bond with the same time to maturity in a market that is just as liquid as the market for corporate bonds. Suppose that investors have a federal tax rate of 30 percent. Calculate the interest rate that Udwellum should pay on its bonds if they will yield the same after-tax rate of return to investors as comparable corporate bonds. Show your work.