Problem:
O'Meara, Inc plans to issue $6 million of perpetual bonds. The face value of each bond is $1000. The semi-annual coupon on the bonds is 4.5%. Market interest rate 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-neutral.
Q1. If the O'Meara bonds are noncallable, what is the price of the bonds?
Q2. If the bonds are callable one year from today at $1250, will their price be greater than or less than the price you computed in (a) ? Why?