Pricing commodity bonds using binomial option pricing

Commodity linked bonds have received considerable attention recently as a way to tailor a developing country's debt repayments to its ability to pay. This report presents a method for pricing commodity-linked bonds in the presence of default risk and a commodity price risk. The advantage of this method is that extensions are very simple. Following an introduction, in part 2 of the report a simple version of the bond is priced to make the process transparent. In part 3, the parameters of the model are derived from real world values. In part 4 the model is extended to incorporate the various features that these bonds can include. Part 5 contains come comparisons of the values obtained by the model with those obtained by the Schwartz model.