Take a look at Schweser’s explanation in the answer. Maybe my brain is fried right now, but it doesn’t make sense to me. An analyst has constructed an interest rate tree for an on-the-run Treasury security. Given equal maturity and coupon, which of the following would have the highest option-adjusted spread? A) A putable corporate bond with a AAA rating. B) A putable corporate bond with a Aaa rating. C) A callable corporate bond with a Baa rating. Your answer: B was incorrect. The correct answer was C) A callable corporate bond with a Baa rating. The bond with the lowest price will have the highest option-adjusted spread. All other things equal, the callable bond with the lowest rating will have the lowest price.
option-adjusted spread = option-removed spread all else equal, the bond with the lowest credit quality will have the highest option adjusted spread
im focusing on the spreads in this question. AAA vs Aaa vs Baa. I do not believe the callable/putable issue is significant. Given equal maturity and coupon, look to the ratings.
is the callable/putable part irrelevant?
The explanation is kind of misleading – no price info. The embedded option is irrelevant; lower rating => higher credit risk ==> higher spread.
Got it. Thanks.
why is the embeedded option irrelevant? i thought that for calls, option cost = z - oas and for puts, option cost = z + oas therefore, option cost differs based on the type of option?
The Q asked which one has the highest OAS (not z-spread). Since the options cost has been “removed” from OAS, only Credit and Liquidity risks left.
deriv108 Wrote: ------------------------------------------------------- > The Q asked which one has the highest OAS (not > z-spread). Since the options cost has been > “removed” from OAS, only Credit and Liquidity > risks left. wow. i get it now. +10