Question

New Business Ventures, Inc., has an outstanding perpetual bond with a coupon rate of 10 percent that can be called in one year. The bond makes annual coupon payments. The call premium is set at $110 over par value. There is a 60 percent chance that the interest rate in one year will be 12 percent, and a 40 percent chance that the interest rate will be 7 percent. If the current interest rate is 10 percent, what is the current market price of the bond? Assume a par value of $1,000. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Calculate the price of the bond when interest rate is 12% as follows:

Price is $982.1429

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Calculate the price of the bond when interest rate is 7% as follows:

Price is $1,028.0374

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Weighted price = (60%*$982.1429) + (40%*$1,028.0374)

Weighted price = $1,000.50