Question 5 (20 marks) CPU, Inc., has decided to issue a perpetual bond. The bond has a face value of $1,000 and makes 10% annual coupon payments. The current one-year interest rate on the bond is 8%. There is a 30% probability that the long-term interest rate one year from today will increase to 10%, and a 70% probability that it will decline to 5%. a) What is the current price of the bond, if the bond is non-callable? (6 marks) b) If CPU decides instead to make the bond callable in one year with a call price at $1,500 per bond, when (if ever) will the company choose to exercise the call option? Why? Will the callable bond have a higher or lower current price compared to the non-callable bond? (5 marks) c) What is current price of the callable bond? (5 marks) d) What is the current value of the call provision to CPU? (4 marks) Question 5 (20 marks) CPU, Inc., has decided to issue a perpetual bond. The bond has a face value of $1,000 and makes 10% annual coupon payments. The current one-year interest rate on the bond is 8%. There is a 30% probability that the long-term interest rate one year from today will increase to 10%, and a 70% probability that it will decline to 5%. a) What is the current price of the bond, if the bond is non-callable? (6 marks) b) If CPU decides instead to make the bond callable in one year with a call price at $1,500 per bond, when (if ever) will the company choose to exercise the call option? Why? Will the callable bond have a higher or lower current price compared to the non-callable bond? (5 marks) c) What is current price of the callable bond? (5 marks) d) What is the current value of the call provision to CPU? (4 marks)