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26 March, 07:28

New Business Ventures, Inc., has an outstanding perpetual bond with a coupon rate of 11 percent that can be called in one year. The bond makes annual coupon payments and has a par value of $1,000. The call premium is set at $125 over par value. There is a 60 percent chance that the interest rate in one year will be 13 percent, and a 40 percent chance that the interest rate will be 9 percent. If the current interest rate is 11 percent, what is the current market price of the bond? (Do not round intermediate calculations and round your answer to 2 decimal places, e. g., 32.16.)

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  1. 26 March, 10:03
    0
    961.88

    Explanation:

    First, examine whether the bond will be called if interest rate falls to 9%. The call price is

    1,000 + 125 = 1,222. Bond price at 9% yield will be

    $110/0.13 > call price of 846.15

    Bond will be called. The price of the callable bond therefore is:

    =+[.60 (846.15) +.40 (1125) ]/1.11+110/1.11 = 961.88
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