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# O'Meara, Inc.: Price of Callable, Non-callable Bonds

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O'Meara Inc. plans to issue \$8 million of perpetual bonds. The face value of each bond is \$1,000. The semi-annual coupon on the bond is 4.5% Market interest rate on one-year bonds are 8%. With equal probability, the long-term market interest rate will be either 12% or 6% next year. Assume investors are risk-neutral.

a. If the O'Meara bonds are noncallable, what is the price of the bonds?

b. If the bonds are callable one year from today at \$1,250, will their price be greater than or less than the price you computed in (a)? Why?

#### Solution Preview

a. If the O'Meara bonds are noncallable, what is the price of the bonds?

Face value= \$1,000
Semi annual coupon rate = 4.50%
Semi annual coupon payment = \$45.00 =4.5%x\$1,000.

Bond price 1 year from now
If the market interest rate = 12%
Semi annual discount rate = 6%
Price of the bond= Semi annual coupon / discount rate = \$750 =\$45./6.%

If the ...

#### Solution Summary

The price of bonds are calculated under two conditions: i) bonds are callable , ii) bonds are non-callable

\$2.19