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Tenor (yr) Spot Rate 1 0.58% 2 0.80% 3 1.01% 4 1.19% 5 1.36% 7 1.67%...

Tenor (yr)

Spot Rate

1

0.58%

2

0.80%

3

1.01%

4

1.19%

5

1.36%

7

1.67%

8

1.79%

9

1.89%

10

1.98%

What is the price of a three-years to maturity risky bond that pays 3% annual coupon if the bond is callable at face value (assuming a face value of $100)?

What is the dollar value of the embedded call option?

Note:An identical bond is currently trading with an OAS of 150 bps, and your analysis of interest rates suggest that the proportional standard deviation of interest rates is 25%.

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Homework Answers

Answer #1
Year 1 2 3
Spot 0.0058 0.008 0.0101
Coupon 3
Coupon/(1+Spot)^year 2.9827 2.95257 2.910906
Sum 8.846176

Price of call-free bond is 8.84 $

Value of embedded bond can be calculated using binomial tree, which requires forward rates. Atleast one forward rate is needed to find out out others using bootstrapping.

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