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The current one year spot rate is 10%, but the rates can change in the future
The current one year spot rate is 10%, but the rates can change in the future.
You estimate that u = 0.9 and d = 0.4.
Now, Value a straight bond with the following features: it matures in three years, has no default risk, pays a 10% coupon each year, and has $1000 face value.
-Assuming that the bond is callable, and the call price is $1010 per bond.
Calculate the price of the callable bond and the value of the call option alone.
Expert Solution
1) Add 1 to value that coupon rate offers ( 10%)- 1 + 0.1= 1.1
2) Raise this value to the number of years before the bond is called- (1.1)3= 1.331
3) Multiply by bonds face value- 1.331 * 1000= 1331
4) Subtract this value from bonds call price= 1331- 1010= 321
Hence, callable bonds value is 321.
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