New Business Ventures, Inc., has an outstanding perpetual bond with a coupon rat

Question

New Business Ventures, Inc., has an outstanding perpetual bond with a coupon rate of 9 percent that can be called in one year. The bond makes annual coupon payments. The call premium is set at $105 over par value. There is a 60 percent chance that the interest rate in one year will be 11 percent, and a 40 percent chance that the interest rate will be 6 percent. If the current interest rate is 9 percent, what is the current market price of the bond? Assume a par value of $1,000. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

New Business Ventures, Inc., has an outstanding perpetual bond with a coupon rate of 9 percent that can be called in one year. The bond makes annual coupon payments. The call premium is set at $105 over par value. There is a 60 percent chance that the interest rate in one year will be 11 percent, and a 40 percent chance that the interest rate will be 6 percent. If the current interest rate is 9 percent, what is the current market price of the bond? Assume a par value of $1,000. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Expected interest rate in one year = (60% × 11%) + (40% × 6%)

= 6.60% + 2.40%

= 9%

Expected interest rate in one year will be 9%.

Par value of bond = $1,000

Coupon rate = 9%

Annual coupon payment = $1,000 × 9%

= $90

Annual coupon payment for bond is $90.

if bond get called in one year then price of bond is calculated below:

Price of bond = ($90 + $1,000 + $105) / (1 + 9%)

= $1,195 / 1.09

= $1,096.33.

if bond get called in one year then price of bond is $1,096.33.

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