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Reading 24 Question 12

In this question they have three comments that you have to choose the correct answer:

1. callable debt has a lower OAS than non-callable.

2.  benchmark corporate bond issues normally have wider spreads than older bonds of the same issuer.

3. The announcement of a new corporate bond issue often leads to an increase in the credit spread on the existing bond. 

I understand comment 3 is correct, but isn’t the first comment true as well? Is this an error?

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The option value for callable bonds is negative. (They are callable by the issuer not the lender so they benefit the issuer.)

OAS = Zspread - Option Value

-Negative option value implies a Higher OAS spread compared to a non callable bond.

¯\_(ツ)_/¯

Sigh.

Have I taught you nothing, grasshopper?

If calculated correctly, the OAS of a callable bond should equal the OAS of an equivalent, option-free bond.

Simplify the complicated side; don't complify the simplicated side.

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That is what I originally thought, but if you look in the first exhibit, the callable bonds have lower OAS than the non-callable. So these would be putable bonds?

I’m not sure if that’s correct. I am seeing this: “For callable bonds, the option benefits the issuer (it allows him to buy back the bonds if rates go down, i.e. bond prices go up), hence OAS<Z. ”OAS<z

Spencer791 wrote:
That is what I originally thought, but if you look in the first exhibit, the callable bonds have lower OAS than the non-callable. So these would be putable bonds?

If they’re otherwise identical, the callable bond should have the same OAS as the straight bond (and the same OAS as an otherwise identical putable bond).

If the OASs are different, then at least one of them was calculated incorrectly.

Color me surprised.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

I’ve seen this topic a couple times in the forums. From my understanding of the curriculum the OAS>Z spread for a putable bond. The OAS<Z spread for a callable bond. Z, I and OAS will be smaller for a putable bond versus an otherwise similar callable bond due to the putable bonds being sold at a premium. 

To be honest none of this has made sense to me other than the comparison of a callable and putable spreads. 

Don't forget to carry the one.

My brain has turned into ice cream

¯\_(ツ)_/¯

BenjaminGraham wrote:
My brain has turned into ice cream

What flavor?

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

S2000magician wrote:

BenjaminGraham wrote:
My brain has turned into ice cream

What flavor?

Vanilla with a hint of Regret Aversion.

¯\_(ツ)_/¯