a. Explaining Yield Differentials Using the most

recent issue of the Wall Street Journal, review the

yields for the following securities:

TYPE MATURITY YIELD

Treasury 10-year ___

Corporate: high-quality 10-year ___

Corporate: medium-quality 10-year ___

Municipal (tax-exempt) 10-year ___

If credit (default) risk is the only reason for the yield

differentials, then what is the default risk premium on

the corporate high-quality bonds? On the mediumquality

bonds?

During a recent recession, high-quality corporate

bonds offered a yield of 0.8 percent above Treasury

bonds while medium-quality bonds offered a yield of

about 3.1 percent above Treasury bonds. How do these

yield differentials compare to the differentials today?

Explain the reason for any change.

Using the information in the previous table, complete

the following table. In Column 2, indicate the before-tax

yield necessary to achieve the existing after-tax yield of

tax-exempt bonds. In Column 3, answer this question:

If the tax-exempt bonds have the same risk and other

features as high-quality corporate bonds, which type of

bond is preferable for investors in each tax bracket?

MARGINAL TAX BRACKET OF INVESTORS EQUIVALENT BEFORE-TAX YIELD PREFERRED BOND 10% ___ ___ 15% ___ ___ 20% ___ ___ 28% ___ ___ 34% ___ ___