Hi, Can anyone confirm: longer eff duration = larger OAS and option costs ? thanks !
anyone ? does longer duration always imply large option cost ? thanks.
key for option cost to remember is Z-OAS = op cost… I don’t know about duration…would like to know too…
two callable bonds with the same price, the one with longer effective duration will have a higher OAS and OC
ro424, that’s what I had in my notes. Still don’t get it though: if you have higher OAS, why would you have higher option cost ? well, whatever, I’ll remember this blindly I guess. thanks !
none of these rules are exact. The callable bond with longer duration SHOULD have the larger OAS to compensate for greater interest rate risk They’ll give you a table. You cant just choose the longest duration and expect it to be the best investment because it has the greatest OAS. They normally make you fill in the stupid table. You want the security will the greatest OAS spread and lowest cost/lowest duration. it depends on the numbers they give you.
polojul: OC will be higher with a longer duration, think of it separately from OAS.
alright, thanks all!
Assuming we are looking at a normal yield curve, the longer the maturity the larger the OAS should be. So, essentially what justin said…
So we know that the bond with the lowest OAS is most expensive, and has the highest option cost, what does duration tell us? I’m not clear how duration plays into this…
ShintreH Wrote: ------------------------------------------------------- > So we know that the bond with the lowest OAS is > most expensive, and has the highest option cost, > what does duration tell us? I’m not clear how > duration plays into this… Duration is a measure of interest rate risk. Higher duration implies the value of the security will change by a greater amount if interest rates change All else equal, you would want higher compensation for a security with higher duration.
OAS = A normal yield curve slopes upward. Thus, a longer duration bond will typically have a higher OAS than a shorter bond all else being equal. If the curve was flat or inverted, this wouldn’t hold. Nothing to do with the option. Option Cost = All options have negative theta. That is, they lose value due to time decay. The reverse of this is that longer dated options are more valuable…think of it this way…If someone offers you two otherwise identical american options, you’d always want to take the one with the longer time to maturity. The option in a bond is no different. Longer maturity means more time for volatility to take its course and for the option to be valuable. Thus OC is ALSO higher for a longer duration bond.