Assume that a law is passed that allows investors to exclude 50% of interest income earned on corporate bond investments from federal taxation. All else equal, which of the following is a
Likely result?

Question

Quizplus · Accepted Answer

With the tax break for interest income on corporate bonds, the demand for these bonds will increase, leading to an increase in their market value. This will be beneficial for companies that issue bonds as they can raise capital at lower costs due to higher market values for their bonds, but it will not have a direct effect on the overall market value of corporate equity or the cost of capital. The provision allowing investors to exclude 50% of interest income earned on corporate bond investments from federal taxation will make corporate bonds more attractive to investors, which will increase demand for these bonds and cause their market values to increase. This will not automatically result in an increase in the overall market value of corporate equity or an increase in the cost of capital for all corporations.

Assume That a Law Is Passed That Allows Investors to Exclude