# OAS question

On schewser notes study session 15 page 291 it says: Tranches trading at a premium (discount) will see gains (loses) when the assumed prepayment rate decreases.

i can’t seem to understand this, can anyone explain?

If the tranche is trading at a premium, _ its coupon rate is higher than its YTM _. If the prepayment rate decreases, then the maturity increases, and you earn higher-than-market rates for a longer period of time: the value of the tranche increases.

If the tranche is trading at a discount, _ its coupon rate is lower than its YTM _. If the prepayment rate decreases, then the maturity increases, and you earn lower-than-market rates for a longer period of time: the value of the tranche decreases.

You can see this easily in straight bonds: when YTM = 5%, a 5-year, semiannual-pay, 6%-coupon, \$1,000 par bond sells at \$1,044; a 10-year, semiannual-pay, 6%-coupon, \$1,000 par bond sells at \$1,078. Above-market returns for longer lead to higher prices.

Similarly, when YTM = 5%, a 5-year, semiannual-pay, 4%-coupon, \$1,000 par bond sells at \$956; a 10-year, semiannual-pay, 4%-coupon, \$1,000 par bond sells at \$922. Below-market returns for longer lead to lower prices.

Thanks again. You just put it in a way it’s so much easier to be understood

You’re welcome.

That’s always my objective. It’s nice to succeed once in a while.

yeah, well done. I understood this…but wouldn’t have been able to articulate as clearly.

Lol when u r a charter holder, u will be haha

haha true.

Please tell whether OAS considers prepayment risk >

It doesn’t.

OAS is option-adjusted spread: all of the options (prepayment, call, put, conversion, cap, floor, accelerated sinking fund, etc.) are removed.