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Perpetual bonds

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KIC, Inc., plans to issue $5 million of perpetual bonds. The face value of each bond is $1,000. The annual coupon on the bonds is 12 percent. Market interest rates on one-year bonds are 11 percent. With equal probability, the long-term market interest rate will be either 14 percent or 7 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are non-callable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,450, will their price be greater than or less than the price you computed in (a)? Why?

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Solution Summary

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

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KIC, Inc., plans to issue $5 million of perpetual bonds. The face value of each bond is $1,000.
The annual coupon on the bonds is 12 percent. Market interest rates on one-year bonds are
11 percent. With equal probability, the long-term market interest rate will be either 14 percent
or 7 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are non-callable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,450, will their price be greater than or less than the price you computed in (a)? ...

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