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    Municipal bonds

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    Municipal bonds might pay a risk premium over the default-free bond yield because:

    A. The default risk on corporate bonds falls below that on municipal bonds.
    B. The default risk on municipal bonds exceeds that on treasury bonds.
    C. The liquidity of municipal bonds exceeds that of treasury bonds.
    D. Default-free treasury bonds include more income tax breaks relative to municipal bonds.

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    Solution Preview

    A. The default risk on corporate bonds falls below that on municipal bonds.

    The default-free bond (i.e. risk-free) will never default, so you may be 100% sure to get your investment back. Risk-free bonds are usually ...

    Solution Summary

    This solution explains why municipal bonds are likely to pay a risk premium over a default-free bond.

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