In part B The investor will make the investment equally in the three securities if the spread is 50 bps over the similar term Treasury. The average spread is 1.22%, but the solution shows 1% being subtracted from 1.22% for a comparison of 50 bps vs 22 bps. Why is 1% subtracted from 1.22%?
did they mention anything about OAS or risk premium?
i think 1% is the maturity premium, remember the average spread includes maturity premiums for bonds in the portfolio the spread of MBS, 95bps, also includes maturity premium, but you may argue that 1-year treasury does not have maturity premium, so the average premium the excess spread 22bps is understated, but i don’t think that will significantly change the result, maybe 10-15bps more
Thank you.