Question

If the income tax exemption on municipal bonds were abolished, what would happen to the interest rates on these bonds? What effect would the change have on interest rates on U.S. Treasury securities?

Short answer

Because of a decline in demand for municipal bonds and an increase in demand for Treasury bonds, the interest rate on municipal bonds will rise while the interest rate on Treasury bonds would fall.

Step-by-step solution

Introduction

A bond is a fixed amount of income investment that is given to an entity for a specific length of time.

To determine

The impact of eliminating the income tax exemption on bond interest rates, as well as the impact of changing interest rates on US Treasury securities

Explanation

Cities, states, and other government organisations issue municipal bonds. Because the tax-exempt benefit would be eliminated, municipal bonds would be less desirable than Treasury bonds.

Because of a decline in demand for municipal bonds and an increase in demand for Treasury bonds, the interest rate on municipal bonds will rise while the interest rate on Treasury bonds would fall.