A firm wishes to issue a perpetual callable bond. The current interest rate is 7%. Next year, the interest rate will be 6.5% or 8.25% with equal probability. The bond is callable at $1,075, and it will be called if the interest rate drops to 6.5%. What is the correct coupon amount if the bond is priced to sell at par?
A) $65.00.
B) $75.42.
C) $82.50.
D) $87.86.

Question

Quizplus · Accepted Answer

The bond will be called if the interest rate drops to 6.5%, so the coupon must be set such that the bond sells at par when the interest rate is 7%. The coupon is calculated as 7% of the par value, which is $1,075, resulting in a coupon of $75.42.

A Firm Wishes to Issue a Perpetual Callable Bond