ABS Valuation

Quick question… IS it right that the higher the OAS (coupled with a low option cost), the “cheaper” the security. I guess I am hoping someone can explain “cheap” vs. “rich” for me in plain english. Thanks

Yeah, I’ve actually been looking for more clarification on this subject as well. If anybody can break this down in simple layman’s terms, I’d appreciate it.

Higher OAS means you are getting higher option adjusted spreads which means that you are getting more for your money. Like now, CMBS AA bonds have risen from around 100 to 300 in the market (I’m generalizing but spreads have widened significantly). So say that libor pays 4% and you had been getting 5%, now you are getting 7%. Higher spreads are cheaper but they generally reflect more risk. It is too general to just say that higher spreads = cheap. you have to look at the asset and understand the risks involved but if you have two identical securities and one has a OAS of 10 and one has an OAS of 50, the 50 OAS is cheaper.

To office monkey’s point, what we consider “rich” and “cheap” in the real world of working with and trading these bonds versus what Schweser wants you to think of when you hear those words is a very different issue. As I did for Level I last year, I have no problem suspending reality for six hours on a Saturday in June.