Bowdeen Manufacturing intends to issue callable, perpetual bonds with annual cou

Question

Bowdeen Manufacturing intends to issue callable, perpetual bonds with annual coupon payments. The bonds are callable at $1,250. One-year interest rates are 11 percent. There is a 60 percent probability that long-term interest rates one year from today will be 13 percent. There is a 60 percent probability that long-term interest rates one year from today will be 13 percent, and a 40 percent probability that they will be 9 percent. Assume that if interest rates fall the bonds will be called. What coupon rate should the bonds have in order to sell at par value?

I don't even really understand what this is asking for. The professor said something about finding the coupon payment first. Any ideas?

PS: This is from Corporate Finance 9e, by Ross, Westerfield, and Jaffe.

Explanation / Answer

Bowdeen Manugacturing company issues callable perpetual bonds with annual coupon payments. Bonds are callable at $1,250 Interest Rate = 11% Assuming that if interest rates fall, then the bonds will be called; There is a 40% probability that long-term interest rates one year from today will be 9% Calculating Coupon Rate, if the bonds to sell at par value: Current Selling Value of the Bond = [Annual Perpetual Coupon Payment / Interest Rate] $1,250 = [Annual Perpetual Coupon Payment / 9%] Annual Coupon Payment = $1,250 * 0.09 Annual Coupon Payment = $112.50

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