How does the steepness of the Treasury yield curve compare with that of the municipal yield curve?
What will be an ideal response?
Assume slopes for both Treasury bonds and municipal bonds are upward sloping. If so, then a steeper municipal yield curve implies that yields for longer term municipal bonds increase more rapidly than for Treasury bonds. This could be caused if certain factors are more prominent in the municipal bond market. For example, if longer term municipal bonds are in shorter supply compared to Treasury bonds, then this factor could lead to greater yields for longer term maturities for municipal bonds. Consequently, a steeper upward sloping yield curve for municipal bonds would result. Similarly, if longer term municipal bonds are seen as increasing more rapidly in terms of credit risk with longer maturities, then the upward slope for yield curves for municipal bonds would be steeper. Finally, investing in municipal securities exposes investors to the same qualitative risks as investing in corporate bonds, with the additional risk that a change in the tax law may affect the price of municipal securities adversely. Since the impact can be greater for longer term maturities, this could cause yield curve for municipal bonds to be steeper.
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