An analyst has constructed an interest rate tree for an on-the-run Treasury security. Given equal maturity and coupon, which of the following would have the highest option-adjusted spread? A) A callable corporate bond with a Baa rating. B) A putable corporate bond with a AAA rating. C) A putable corporate bond with a Aaa rating. Your answer: A was correct! 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. can someone elaborate on this answer. I have no idea how to even approach this problem. i cant even find the LOS associated with this…

Lets talk about OAS later, but in general, the higher the risk, the higher the spread. Clearly, the Baa bond has more risk.

ok since the option cost portion the z spread is fixed, the higher risk implies a higher Z spread, thus a higher OAS?

The OAS removes the effect of the embedded option so in this case all you have to look at are the bond ratings. Answer should be A

yep. OAS gets rid of the options. so we are left between straight (optionless) Baa, AAA and Aaa bonds.