Consider a coupon bond with per period payment c=5 and an unknown maturity date

Question

Consider a coupon bond with per period payment c=5 and an unknown maturity date n > 1. In the next period (t + 1) you will go to college, and you will need to liquidate (sell) this bond. You expect that in t + 1 the supply of this bond will be given by

S:P=2Q
Unlike supply which is certain, demand could be given by

DH : P = 100 2 Q or DL : P = 60 2 Q

with equal probability.
Suppose that the rate at which you discount the future is 10 per cent. What

is the price Pt that you would be willing to pay in order to buy this bond today together with the option to sell it in period t + 1 for 40 dollars?

Explanation / Answer

Consider a coupon bond with per period payment c=5 and an unknown maturity date

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