Problem: O'Meara Inc plans to issue 6 million of perpetual bonds. The face value of each bond is $1,000. The semi-annual coupon on the bonds is 4.5%.
Market interest rates on one-year bonds are 8%.
With equal probability, the long-term market interest rate will be either 12% or 6% next year. Assume investors are risk-nuetral.
1) IF the O'Meara bonds are noncallable, what is the price of the bonds?
2) If the bonds are callable one year from today at $1,250, will their price be greater than or less than the price you computed in (a)? WHY?