Please help with the following problem. Provide step by step calculations.
Bowdeen Manufacturing intends to issue callable, perpetual bonds with annual coupon payments. The bonds are callable at $1,250. One-year interest rates are 10 percent. There is a 50 percent probability that long-term interest rates one year from today will be 15 percent, and a 50 percent probability that they will be 7 percent. Please assume that, if interest rates fall, the bonds will be called.
Which coupon rate should the bonds have in order to sell at par value?© BrainMass Inc. brainmass.com June 4, 2020, 3:16 am ad1c9bdddf
Problem: Which coupon rate should the bonds have in order to sell at par value?
Let the coupon amount be C.
If the interest rates increase to 15% in one year from now, then the following occurs.
The cash flow to the customer after one year=CF1=Coupon amount+Expected price at the end of year 1=(C+C/15%)=7.666667 ...
This solution describes the steps to estimate the coupon rate at which given bond can sell at par in the probabilistic scenario.