What circumstances firms would want to issue callable bonds

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Reference no: EM132791211

Consider the following evolution of interest rates, i. Price a 3-year zero-coupon bond (F=100) which is callable at 96 at T=1 and at 98 at T=2. You can (in approximation) view this bond as a portfolio of a long position in the zero coupon bond, a short position in a European call option with a strike price 96 and maturity T=1, and a short position in a European call option with a strike 98 and maturity T=2.

Problem a) What are the prices of an underlying non-callable zero coupon bond for each of the six nodes in the tree?

Problem b) Price a call option on the zero coupon bond in (a) with the strike price 96 and maturity T=1

Problem c) Price a call option on the zero coupon bond in (a) with the strike price 98 and maturity T=2.

Problem d) What is the price of this bond? (Hint: The value of the option-embedded bond = Price of the zero coupon bond - price of the two call options)

Problem e) Under what circumstances firms would want to issue callable bonds? Explain

Reference no: EM132791211

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