KK Corporation has an outstanding perpetual bond that has a par value of $1,000, and pays coupon annually (coupon rate 10%). The current market interest rate is 10%. You believe that there is a 60% chance that next years interest rate will fall to 6%, and a 40% chance that it will increase to 13%.

(a) What is the price of the bond? (8 marks)

(b) What is the price of the bond if it was callable in one year and has a call premium of $300? (7 marks)