In this Q a Co has a 7% puttable bond and a 8% callable bond. Part (v) asks about the circumstances when the Co may have to refinance these. I thought that the puttable will be refinanced if interest rates are higher than 7% and the callable bond if interest rates are lower than 8%. I agree with most of the solution given, but I do not understand the last 2 sentences of this part: "If interest rates turn out to be between 7% and 8% then it is likely that neither bond will be redeemed early." and "Under no circumstances will both bonds be redeemed early". I thought that if interest rates turn out between 7% and 8% then both may be refinanced?
I completely agree that the options embedded in both bonds would be exercised if interest rates are between 7% and 8%.
Assume its the year 2004, the year both bonds are issued by XYZ (I assume both are 20 year bonds - although it is only mentioned that the callable bond is 20 years). Long term interest rates are currently 5%. Assume that the interest rate rises (in general) so that in 2009 it is about 7.5%. The call would be exercised because long term interest rate<8%. The put would be exercised because long term interest rate>7%.
