Suppose that the current market value of a firm is 150. The firm lasts for two p

Question

Suppose that the current market value of a firm is 150. The firm lasts for two periods.
The rate of return on the assets of the firm, over one period, is either 20% or -20% with
equal probabilities. The riskless rate of interest is 5% in each period. If any cash payout,
coupon and/or dividend, is made at the end of the first period, then the ex-payout firm
value will change by either 20% or -20% over the second period.
1. Consider a callable bond with the coupon rate of 6.56% and the face value of 100.
The call price on an ex-coupon basis is 100. The firm pays no dividends on the stock
at the end of the first period. What is the price of this callable bond? What is value
of the call provision?

Explanation / Answer

The price of the bond can be calculated as follows-

NPER

RATE

PV

PMT

FV

Given

2

20%

6.56

100

Solve for PV

-79.4667

By using Excel sheet and the formula of PV, we can find out the price of the callable bond. It is $79.46.

NPER

RATE

PV

PMT

FV

Given

2

20%

6.56

100

Solve for PV

-79.4667

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