Municipal bonds have default risk,yet their interest rates are usually lower than the rates on default-free Treasury bonds. This suggests that
A)the benefit from the tax-exempt status of municipal bonds is less than their default risk.
B)the benefit from the tax-exempt status of municipal bonds equals their default risk.
C)the benefit from the tax-exempt status of municipal bonds exceeds their default risk.
D)Treasury bonds are not default-free.

Question

Quizplus · Accepted Answer

The lower interest rates on municipal bonds suggest that their tax-exempt status provides a greater benefit than their default risk. Despite the default risk, investors are willing to accept lower yields because they can avoid paying taxes on their interest income, resulting in a higher after-tax return than they would receive from investing in Treasury bonds.

Municipal Bonds Have Default Risk,yet Their Interest Rates Are Usually