Can you please get me on the right track. This is kinda confusing me. Why do you use the OAS spread to discount a callable bond instead of z spread.
like when will OAS be larger than Z spread, and vice versa
oas must be used in binomial model because it can account for multiple interest rate paths–zsppread only accoutns for spread over the treasury curve. oas is smaller larger than zspread because by definition it is the zspread minus the option cost: oas = zspread - option cost
oas adjusts the z-spread for the option. zpread = oas + option costs so oas reflects credit risk, liquidity risk, term risk, etc. want oas to be wide, i.e. large spread holding everything else equal for relative value
Both OAS and Z-spread are based on the benchmark of treasury spot rate curve. For bonds with embedded options, the OAS spread and Z-spread would differ. OAS is the spread you would receive if the corporate bond has no embedded options. For Callable Bonds: OAS < Z-Spread Value of the Embedded(Call) Option % = Z-Spread - OAS Pnon-callable bond = PV of cash flows discounted by the OAS Call Value() = Pnon callable bond - Pcallable bond For Puttable Bonds: \*\*OAS \> Z-Spread Value of the Embedded(Put) Option % = OAS - Z-Spread Pnon-puttable bond = PV of cash flows discounted by the OAS Put Value() = Pputtable bond - Pnon-puttable bond