R56 EOC #28 - Bond with call option

  1. Today’s ex-coupon price of the callable Wentz bond is closest to: Answer: C. 105.0263 How could Wentz bond be priced over 104? It is callable tomorrow and the value should be capped by the strike price.

there is time value of coupon payments which are cash flows

I understand that if the bond is called, the bondholder wouldn’t receive the coupon. If you are buying the bond today at 105 and tomorrow it’s called at 104, that’s an instantaneous loss.

I would say the value is exceeding 104 due to the coupon being higher than current interest rates. Even though the bond may be called at one of the next nodes, the bond investor is still entitled to receive coupon above market rates for at minimum one year. This gives him an income above opportunity cost (market interest rates) and thus increases value of the bond.