# Bond Z spread question...I'm lost again

Kwagmyre Investments, Ltd., hold two bonds: a callable bond issued by Mudd Manufacturing Inc. and a putable bond issued by Precarious Builders. Both bonds have option adjusted spreads (OAS) of 135 basis points (bp). Kevin Grisly, a junior analyst at the firm, makes the following statements (each statement is independent). Apparently, Grisly could benefit from a CFA review course, because the only statement that could be accurate is: A) Given a nominal spread for Precarious Builders of 110 bp, the option cost is -25 bp. B) The cost of the call option on the Mudd bond is -15bp. C) The spread over the spot rates for a Treasury security similar to Mudd’s bond is 145 bp. D) The Z-spread for Mudd’s bond is based on the YTM. Ok…I’m lost. Can anybody help me out with this question?

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The correct answer was C) The spread over the spot rates for a Treasury security similar to Mudd’s bond is 145 bp. If anybody can help me out with this question, I would be grateful.

I’m in the dark too thought it was A

i have no clue… the formula is z spread - oas = price of the option… a-- is wrong b/c they are giving you the nominal spread not the z spread and since we know both of these bonds have options the nominal is not equal to the z spread… b–cost of a call option is positive z - oas = positive… we get money for the call option… it is better for the buyer they pay us… c-- i have no clue about… d-- the z spread is not based on ytm… so i was left w/ c to choose… and i didnt pick it because i figured if it was something i had no idea about it was a curve ball so i went against my better judgement a setled w/ d… lol i am an idiot… i hope i do not do this on the test

nikko is right about his explanations on a, b, d here is why C is correct – when the question asks “similar treasury” it means coupon and maturity so imagine you have a 5% 10yr callable corporate bond vs a 5% 10yr bullet Treasury. if they are issued at the same price, its cheaper (better value) to buy the bullet since there is no option that can hurt you. in a callable bond you are short the option. SO, if you know the OAS of the callable is 135, the z-spread is going to be higher (since oas + option cost = z-spread). we dont know what it will be, but it will be more than 135. a similar treasury, without the option, will have a spread greater than 135. so C could be right since it COULD be 145

Actually, I believe that the z-spread would be lower given a callable bond because the option cost is Negative. Callable Bond = option free bond - call option Therefore: z-spread = OAS - call option (for callable bond) VS. z-spread = OAS (for treasury bond without option) So, the spread could be 145 for the treasury bond. I think?

I guess I dont understand why it couldnt be B now…UGH, now im confused