The risk-free rates with maturities of 6,12 , and 18 months are, respectively, \(2.3 \%, 2.8 \%\), and \(3.2 \%\) (with continuous compounding). We also have the following swap rates:

We assume semiannual payments, and the swap rates are semiannually compounded (this is consistent with market conventions). For the sake of simplicity, we neglect day count issues and take for granted that all months consist of 30 days. A callable bond with no default risk has coupon rate \(10 \%\) and matures in two years. The bond trades for €97.12. What is the value of a call option on the corresponding noncallable bond?

Transcribed Image Text:

Maturity Bid Offer 2 years 3.4 3.6 2.5 years 3.6 3.9 3 years 3.9 4.2