Current market price of the bond
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Neues Geschaft, Inc., has an outstanding perpetual bond with a 10% coupon rate that can be called in one year. The bonds make annual coupon payments.
The call premium is set at $150 over par value. There is a 40% chance that the interest rate in one year will be 12%, and a 60% chance that the interest rate will be 7%. If the current interest rate is 10%, what is the current market price of the bond?
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Solution Summary
The solution explains how to calculate the current market price of the bond
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The price of the bond today would be the present value of the cash flows from the bond.
We estimate the cash flows at the end of 1 year for the bond holders and then use these to calculate the price today.
If the interest rate in one year is 12%, the bonds would not be called as the price would be lower than the call ...
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