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Bay Nuclear Power Plant (BNP) is looking to raise $120 million in a short amount of time. Mani Lau (Mani), the finance director, advised that BNP issue perpetual bonds with a $1,000 face value and an annual coupon rate of 8.1 percent. The market interest rate is currently at 8%. Mani believes there is a 0.3 probability that the interest rate will rise to 10% next year, and a 0.7 chance that it will decline to 6%.

Question:

The chairperson, Philips Chuang (Philips), decides to add a call provision into the bond contract and make the bonds callable in one year. Determine what the new coupon rate of the callable bonds should be if the bonds are issued at par. Assume that the bonds will be called if the interest rates fall and the call premium is set at $150 over par value.