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 8 percent that can be called in one year. The bond makes annual coupon payments. The call premium is set at $100 over par value. There is a 60 percent chance that the interest rate in one year will be 10 percent, and a 40 percent chance that the interest rate will be 5 percent. If the current interest rate is 8 percent, what is the current market price of the bond? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

New Business Ventures, Inc., has an outstanding perpetual bond with a coupon rate of 8 percent that can be called in one year. The bond makes annual coupon payments. The call premium is set at $100 over par value. There is a 60 percent chance that the interest rate in one year will be 10 percent, and a 40 percent chance that the interest rate will be 5 percent. If the current interest rate is 8 percent, what is the current market price of the bond? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Assuming par value of 1000 as coupon rate is equal to ytm current price of straight bond will be 1000

But as it is a callable bond:

When rates are 10%, as rates are more than the current rate the bond will not be called and hence price of the bond will be min(1100,8%*1000/10%)=1000*8%/10%=800

When rates are 5%, as rates are less than the current rate the bond will be called and hence price of the bond will be min(1100,5%*1000/10%)=1100

Current market price of the bond=(0.6*800+0.4*1100)/(1+8%)=851.8518519

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