Question: Gustav Co. produces cat food and is planning to issue $10 million of bonds with a coupon rate of 7 percent and 20 years to maturity. The current market interest rates on these bonds are 6 percent. In one year, the interest rate on the bonds will be either 10 percent or 5 percent with equal probability. Assume investors are risk-neutral.
a. If the bonds are non-callable, what is the price of the bonds today?
b. If the bonds are callable one year from today at $1,070, will their price be greater or less than the price you computed in (a)? Why?