Company decided to borrow money by issuing perpetual bonds with coupon rate of 7

Question

Company decided to borrow money by issuing perpetual bonds with coupon rate of 7.5%, payable annually. The one year interest rate 7.5%. Next year, there is 40% probability interest rate will increase to 8%, there is 40% chance rates will fall to 5%. Assume par $1000. A. If co decides to make bonds callable in 1 year what coupon rate will be demanded by bond holders to sell at par? Coupon rate? B. What will value of the Call provision to the company? Company decided to borrow money by issuing perpetual bonds with coupon rate of 7.5%, payable annually. The one year interest rate 7.5%. Next year, there is 40% probability interest rate will increase to 8%, there is 40% chance rates will fall to 5%. Assume par $1000. A. If co decides to make bonds callable in 1 year what coupon rate will be demanded by bond holders to sell at par? Coupon rate? B. What will value of the Call provision to the company? B. What will value of the Call provision to the company?

Explanation / Answer

1. Coupon rate = Sum of bond annual coupon payment

Bond par value

= 75

   1000

= 7.5 %

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