Official mock 2019
“It is my understanding that as interest rate volatility declines, the OAS for callable bonds decreases while the OAS for putable bonds increases.”
The statement is incorrect.
As interest rate volatility declines, the embedded call option becomes cheaper; thus, the higher the arbitrage-free value (or model value) of the callable bond.
Callable bond value = Value of straight bond – Value of call option
A higher value for the callable bond means that a higher spread needs to be added to one-period forward rates to make the arbitrage-free bond value equal to the market price (i.e., the OAS is higher).
Could any one explain the answer? I just think that the call option is price less while volatility declines, and the price of the callable bond increase, so the OAS decrese. [Price=CFi/(1+ri+OAS)]
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