Did any of you have a problem with the calculation of OAS?? Seems to me there is a contradiction in the calculation of OAS in level 2 and 1. Level 1 says OAS is the spread added to Treasury Spot to let the PV of cash flows equal to its market price of a option free bond. Level 2 says to calculate the value of a MBS, the spread is added to Treasury Spot to equal Market Value. The contradiction as far as I see it, is that the prepayment option is effectively a call option, and the cash flows for a MBS included a prepayment rate. I think the bit I dont understand (potentially) is that they haven’t really taught us how to calculate the z-spread. If you look at the z-spread calc in level one its for a option free bond. The beautiful thing is… spoke to a Bond Trader here yesterday, and they dont use OAS or any other measure that deals with moving the underlying spot rate curve. They simply use the Black and Scholes to value the price of the call option.
Say what? Using B-S with MBS just doesn’t work. I think they concepually taught you how to calculate OAS on MBS in LII using both Monte Carlo and binomial pricing. I think they aught you even more explicitly in LI how to do it except that they didn’t teach you a numerical technique to get it. Anyway, for an option-free bond the numerical problem for OAS is the same as finding ytm. The only difference is that your calculator has a ytm button to save you from that numerical problem. I’m sure a google search will turn up tons of Excel OAS calculators.