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Suppose that the Johnson family has the option of purchasing two bonds. • Bond A is a $4000 10% 10 year bond paying annual coupons with redemption value $2000, which can be purchased at a premium for $3000. This bond can optionally be sold at the end of the 5th year for 6,000. • Bond B is a $4000 10% 10 year bond paying annual coupons with redemption value $3000, which can be purchased at a discount for $2000. Suppose further that this bond has a lockout period of 5 years, after which a put option can be placed at the end of years {6, 7, 8, 9} for put premium of $150. Explain to the Johnson family which bond option you would recommend they invest in, and at which time (if any) they should exercise their put and/or selling option. What are their gains in terms of yield rates depending on the bond they choose and which put option they choose to exercise (in the case of Bond B), or if they choose to sell (in the case of Bond A) ?
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