26 Bond Refunding Infineon AG plans to issue €500 million of bonds with a face value of €100,000, coupon rate of 3.5 per cent and 10 years to maturity. The current market interest rate on these bonds is 6 per cent.

In one year, the interest rate on the bonds will be either 8 per cent or 5 per cent with equal probability.

Assume investors are risk-neutral.

(a) If the bonds are non-callable, what is the price of the bonds today?

(b) If the bonds are callable one year from today at €120,000, will their price be greater than or less than the price you computed in (a)? Why?