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 noncallable, 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 part (a) why?
a) The expected interest rate next year = 14%*0.5+7%*0.5=10.5%
The value of a perpetual bond next year = Annual coupon / ...
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