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Unformatted text preview: bonds in one year will be: P1= C + C / .09 If interest rates fall, the assumption is that the bonds will be called. In this case, the bondholders will receive the call price, plus the coupon payment, C. The call premium is not fixed, but it is the same as the coupon rate, so the price of the bonds if interest rates fall will be: P1= ($1,000 + C) + C P1= $1,000 + 2C The selling price today of the bonds is the PV of the expected payoffs to the bondholders. To find the coupon rate, we can set the desired issue price equal to present value of the expected value of end of year payoffs, and solve for C. Doing so, we find: P0= $1,000 = [.35(C + C / .09) + .65($1,000 + 2C)] / 1.08 C = $77.63 So the coupon rate necessary to sell the bonds at par value will be: Coupon rate = $77.633 / $1,000 Coupon rate = .0776 or 7.76% References and cited sources: End of Chapter Solutions Corporate Finance 8th edition Ross, Westerfield, and Jaffe Updated 12-20-2008...
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