# OAS question

I don’t understand this question. Since OAS on a callable bond is equal to Z spread - option cost. Shouldn’t the OAS on a putable bond equal to Z spread + option cost? Doesn’t that mean OAS would be greater than Z spread on a putable bond? Or I understand this totally wrong? Below is a question totally confuses me. Someone please help!!!

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.

No. The OAS is always the Z-spread minus the option value. In the case of the put option, that value is negative , but you’re still subtracting it from the Z-spread; when you subtract a negative value you get a bigger answer.

Remember that the OAS is the spread with the value of the option removed. They’re correct: the bond with the lowest price will have the highest OAS: to get a lower price you have to discount with higher interest rates.

I believe that your confusion stems from an assumption that you made without realizing that you made it: you assumed that the Z-spread for all three bonds is the same. If that were true, then the putable would unquestionable have the highest OAS. However, because of the different credit ratings, we can be certain that the Z-spreads aren’t all the same.

Hmmm…ok I did assume for all straight bond, callable bond and putable bond all have the same z spread over the same bench mark(for example: the treasury yield curve), and putable would have the highest OAS under this assumption. Are you saying the z spread varies based on the type of bond? In another word a putable bond would have a different z spread compared to a callable bond holding all other factors equal?

Yes, ceteris paribus, a putable bond will have a different Z-spread than a callable bond. They should have the same OAS.

Note that in this example, ceteris is explicitly not paribus.

Ok thanks again. I don’t know how you know all this stuff like the back of your hand. Haha…maybe you should be the next Peter Olinto and teach this stuff lol

My pleasure.

I know how I know it.

Maybe I am. (The next time I talk to Peter I’ll tell him that you said so.)

Haha ok, he’s actually my high school friend’s 3rd cousin. Lol and I did take hhis live course for level 1 before schweser bought stalla.

I was the Level III curriculum manager for Stalla for 18 months and lead instructor for Stalla for Los Angeles and Orange Counties. I enjoyed working with Peter. He’s aces.

Oh wow…I’m getting an expert advise. I’d better pass lol

And thx again!

You flatter me.

I’ll drink to that.

My pleasure.

Ok one last question for the night…promise

What adjustment must be made to the key rate durations to measure the risk of a steepening of an already upward sloping yield curve? A) Increase all key rates by the same amount. B) Increase the key rates at the short end of the yield curve. C) Decrease the key rates at the short end of the yield curve. Your answer: B was incorrect. The correct answer was C) Decrease the key rates at the short end of the yield curve. Decreasing the key rates at the short end of the yield curve makes an upward sloping yield curve steeper. Performing the corresponding change in portfolio value will determine the risk of a steepening yield curve.

Is your question, “Why is this answer correct?”? You’re trying to simulate the effect of a steepening yield curve. You can do this by lowering the key rates at the short end of the yield curve or increasing the rates at the long end of the yield curve.

Ok thanks. I thought the question already states the curve is steepened, so you need to increase the short term end to “flatten” it out. I guess I understood the question wrong. Thx again, ok back to the grind less than 2 months to go…

Ok thanks. I thought the question already states the curve is steepened, so you need to increase the short term end to “flatten” it out. I guess I understood the question wrong. Thx again, ok back to the grind less than 2 months to go…

I e-mailed Peter over the weekend. His response: “That is too funny!”