XYZ Corporation plans to issue perpetual bonds (par value = $1,000) with a coupon rate of 8% paid annually. The current market interest rates on these bonds are 7%. In one year, the interest rate on the bonds will be either 10% or 4% with equal probability.

1. If the bonds are noncallable, what is the price of the bonds today? (5 marks)
2. If the bonds are callable one year from now at $1,100, what is the price of the bonds
3. today? (7 marks)
4. What is the compensation for bearing the call risk of XYZ's callable bonds? (3 marks)