Question
Illinois Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 7.5 percent, payable annually. The one year interest rate
Illinois Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 7.5 percent, payable annually. The one year interest rate is 7.5 percent. Next year, there is a 30 percent probability that interest rates will increase to 9 percent and there is a 70 percent probability that they will fall to 6 percent. Question: If the company decides instead to make the bonds callable in one year, what coupon rate ill be demanded by the bondholders for the bonds to sell at par? Assume that the bonds will be called if interest rates fall and the call premium is equal to the annual coupon. Please show steps.
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