Question
Calculate the price of a 5% coupon, $1000 face value 5 year bond thats callable after one year for $1030 if theres an equal chance
Calculate the price of a 5% coupon, $1000 face value 5 year bond thats callable after one year for $1030 if theres an equal chance that interest rates for each of the next five years will be 4%, 5% or 6% (in all cases, rates will be constant for all five years so either 4%, 4%, 4%, 4%, 4% or 5%, 5%, 5%, 5%, 5% or 6%, 6%, 6%, 6%, 6%). Assume the call provision can only be exercised after the first coupon is paid (at the so called coupon anniversary). If the probability that both 4% and 6% falls to 10% (leaving the average rate the same: 5%), the price of this bond will rise. Intuitively, explain why?
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