New England Property and Casualty

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New England Property and Casualty 1). What factors influence the demand for municipal debt? Explain the steep positive slope of the municipal yield curve. The primary factors affecting demand for municipal bonds are interest rate volatility, taxes, and relatively low levels of default. Municipal bonds had traditionally been considered an effective investment vehicle for property casualty insurance companies and for individuals in high federal tax brackets. For that reason, face value yields on muni bonds are generally below those of Treasuries given the net premium after-tax considerations. At the time of the case, the top marginal federal income tax rate was over 50% (not including state and local taxes). In the years leading up to the case, both interest rates and the marginal tax rate had been very volatile. The top marginal tax rate at the time the portfolio had been purchased was 70%, it then fell to 50% and was scheduled to drop further in the coming years. Ratings are also a factor influencing the demand for municipal debt. Ratings are affected by issuing municipality’s economic base, debt history, future capital requirements, etc. High ratings usually represent the professionalism of a municipality’s administration and the quality of its control systems. Investors’ duration of liabilities and regulatory restriction on the quality of securities in which they could invest also influence the demand for municipal debt. Commercial banks generally purchased short- to intermediate-term, general obligation municipal bonds. Property and casualty companies prefer the long term municipal bonds, exhibiting a preference for higher-yielding revenue bonds. [pic][pic] The steep positive slope of the muni bond yield curve at the time of the case reflects high demand for short term muni bonds and decreased demand for LT munis requiring greater yields. This

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