OAS of callable and non-callable bond (Book 4, reading 25, EOC #12)

Reading 25 (Book 4) EOC question #12 states that “Callable debt has a smaller OAS than comparable non-callable debt”.

In my opinion, this statement is correct. However, in the answer says that this statement is not correct. Therefore, the opposite must be true.

Could someone please explain why OAS of non-callable debt is larger than OAS of callable debt?

OAS of callable bond = z spread - call option cost (since we are short the call)

OAS of straight bond = z spread of that bond

OAS of putable bond = z spread + put option cost (since we are long the put)

Hope this helps.

In addition to Saurabh, OAS of non-callable is larger because is not adjusted for Call option value and this is exactly a z-spread of non- callable bond.

There was another thread on this subject a while ago.

If the bonds are priced fairly, the OAS of a callable bond and the OAS of a putable bond should be the same as the OAS of the comparable, option-free bond. That’s the point of OAS: it removes the effect of the option, leaving you with a spread on the underlying, option-free bond.

So it should not be smaller, and it should _ not _ be larger; it should be the same.

Thanks guys! I really appreciate it :slight_smile:

Not if the bonds are priced fairly.

Good to know.

Hmmm shouldn’t the above instead be asking why non-callable debt has smaller OAS than callable? Or in other words why callable debt has larger OAS than non-callable?

In fact the textbook states in 4.1.4 “As another example, callable debt often has a larger option-adjusted spread than otherwise comparable non-callable debt.” this statement in the textbook seems incorrect?