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-neutral.
a. If the O'Meara bonds are non callable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,250, will their price be greater or less than the price you computed in (a)? Why?