answer given in schweser pg 163 book 5 : question was, bond has a z spread of 1.4% and oas of 1.2% since the oas is less than the z spread, the effect of the embedded option is to decrease the required yield so it must be a put option and not a call option… text says that for embedded puts; option cost < 0, oas > zspread if the oas is lower than the zspread in the question, why isnt it a call option??
there is a cost to this option, hence it must be a put option.
Z-Spread = OAS + option cost 1.4 = 1.2 + Option cost option cost = 0.2, must be a call option
this is a call option and I personally submitted the error to Schweser and it was corrected.
It is like below: - If the investor has sold a call option to the issuer and the OASZ-spread, then the cost of the embedded option is negative
nogiveup Wrote: ------------------------------------------------------- > this is a call option and I personally submitted > the error to Schweser and it was corrected. great…yet another question to further my confusion on this subject…this is how i have it memorized for test taking purposes;; oas - call lowest…zspread…middle…oas-put highest… if oas is less than z then positive value on option…if oas is more than z, then negative value on option…this makes sens right?
What??? if OAS is less than zspread, that means there is a positive cost to option, hence it must be a put option. if OAS is more than zspread, that means there is a negative cost to option, hence it must be a call, because call is a negative property for an investor, where as put is a positive property.
pepp Wrote: ------------------------------------------------------- > What??? > > if OAS is less than zspread, that means there is a > positive cost to option, hence it must be a put > option. > > if OAS is more than zspread, that means there is a > negative cost to option, hence it must be a call, > because call is a negative property for an > investor, where as put is a positive property. OAS < z-spread means that the issuer must pay extra due to the option, and so the option must be in his favor (call option) and vice versa
getting all messed up. gotta read again. damn!
pepp, think about it this way…the additional spread is there in order to compensate the investor for the call feature.
this my memorization method, i think it will hold water in test questions…imagins three bars like a bar graph… oas-call is the shortest…zspread is the middle, oas-put is the highest… zspread-oascall= positive value…and z will be higher than oas call oas put-zspread= negative value’…and put z will be higher bar than z (higher value)
yeah make sense. just got it inverted. additional spread to compensate the investor cuz there is a call feature. PERFECT ANSWER!!
\
You can also think of it this way: 1. The price of a callable bond is LOWER than a noncallable bond (because investors pay less if it can be called away from them). 2. Since the callable bond’s price is LOWER , its yield must be HIGHER than a NonC bond. 3. This higher yield needs to be adjusted by subtracting, not adding because it is higher. 4. By subtracting, you will have a LOWER spread. Thus a lower spread is due to a call option feaure. If the OAS increases, then it will be due to a put feature. Makes sense?