Z-Spread/Nominal/OAS: Accounts for Options?

CFA Level I
#1

Hey guys, Sorry if this has been beat to the ground before, couldn’t find any specific threads on it. I am a little confused on which of these spreads account for/don’t account for options. My understanding: Nominal Spread: Accounts for Option Z-Spread: Accounts for Option OAS: Doesn’t account for Option Can some one set this straight?

#2

i know it is confusing!! i think of it this way… Nominal spread and z-spread do not account for option cost (b/c they hide it by not making it explicit) OAS accounts for option cost by separating it away

#3

thisisbrianly Wrote: ------------------------------------------------------- > Hey guys, > > Sorry if this has been beat to the ground before, > couldn’t find any specific threads on it. I am a > little confused on which of these spreads account > for/don’t account for options. > > My understanding: > Nominal Spread: Accounts for Option > Z-Spread: Accounts for Option > OAS: Doesn’t account for Option > > Can some one set this straight? OAS is the spread you actually get. It is what you get paid for taking liquidity and credit risk (in case of corporate bond). You get OAS once you have removed the extra yield you get due to the call option or you have added back the yield that you don’t get due to the put option. OAS is what you would have gotten, had the option not been there embedded in the bond. Say if z spread is 5% on a straight bond and 7% on a callable bond, you cannot compare these. Say, you find that OAS for callable bond is 4% (you remove the extra 3% you got due to the risk of call option being called). OAS for straight bond = z spread = 5%. Now you compare them. Nominal Spread and Z spread have all 3 risk premiums combined into 1 figure so they are not useful to judge the yields of option embedded bonds.

#4

@Anish . I like that explanation, thanks

#5

Thanks guys!

#6

Good stuff anish

#7

Thanks Anish, good explanation