I was going through Mock 2011 and I’m a little confused about Q # 16 from AM section.

Doesn’t the OAS compensate for Credit, Liquidity and Option Risk?

I know it’s the spread over the spot curve but I thought it compensated for all three of those risk factors.

Any thoughts?

I did have not reached the mock 2011 yet. But OAS itself only reflects Credit and Liquidity risk. The optionality feature is already removed. Which is the reason why Z spread = OAS + Option Cost where Z spread itself reflects all 3 of the risks (credit, liqudity, and option).

No, OAS represent the Credit and Liqudity risk. In fact Schewser mentions that it should better be named “option removed spead”

Thanks! I won’t forget that now!

It will always be remembered as option removed spread.