On 1 October 2016, you are reviewing two fixed-rate bonds issued by a local firm, the two bonds, whose characteristics are given in the table below: (25 marks)

Bond

Maturity

Coupon

Type of Bond

Bond A

1 October 2019

6.5% annual

Callable at par on 1 October 2017 and on 1 October 2018

Bond B

1 October 2019

6.5% annual

Putable at par on 1 October 2017 and on 1 October 2018

Based on an estimated interest rate volatility of 20%, you constructed the binomialannualinterest rate tree shown below.

0.0450.058810.096070.039420.064400.04317

1)Calculate the value of Bond A and Bond B.(21 marks)

2)Which bond would most likely protect investors against a significant increase in interest rates?(2 marks)

3)All else being equal if you assume an interest rate volatility of 25% instead of 20%, the bond that wouldmost likelyincrease in value is:(2 marks)