Callable Bonds

Note 1: Assume that bonds have semi-annual coupons unless told otherwise. Note 2: In order to simplify, most of these questions are about perpetual bonds Problem 1 Feel Good Clothing Ltd Bond Pricing (RWJI, Ch. 20, Q3) Feel Good Clothing Inc plans to issue $5 million of bonds with a coupon rate of 12 percent and 30 years to maturity. The current market interest rates on these bonds is 11 percent. In one year, the interest rate on the bonds will be either 14 percent or 7 percent with equal probability. Assume investors are risk neutral. (a) If the bonds are noncallable, what is the price of the bonds today? (b) If the bonds are recallable one year from today at $1,450, will their price be greater than or less than the price you computed in (a)? Why? (Please note that this does not require any computations - it is conceptual) Problem 2 New Business Ventures Bond Pricing (RWJI, Ch. 20, Q4) New Business Ventures Inc has an outstanding perpetual bond with a 10 percent coupon rate that can be called in one year. The bonds make annual coupon payments. The call premium is set at $150 over the par value. There is a 40 percent chance that the interest rate in one year will be 12 percent, and a 60 percent chance that the interest rate will be 7 percent. If the current interest rate is 9 percent, what is the current price of the bond