Why is the answer B?
to get the value to the same price OAS for 6 is less than 7.
Do you want to earn higher interest or lower interest for the same level of risk?
A higher interest rate.
I am still not able to understand the statement :“An OAS lower than that for a bond with similar characteristics and credit quality indicates that the bond is likely overpriced (rich) and should be avoided. A larger OAS than that of a bond with similar characteristics and credit quality means that the bond is likely underpriced (cheap)” CFAI book pg 147.
Suppose a bond A is at 101 its market price is 100 we add an OAS of 28 to get to the market price similarly a bond B is at 101 its market price is 100 we add an OAS of 26 to get to the market price then why would A be underpriced just because it has OAS 28?
If Bond A and Bond B have the same level of risk, they should have the same return. If Bond A has an OAS of 28 bps and Bond B has an OAS of 26 bps, then you’re earning 2 bps more spread (i.e., interest; i.e., return) on Bond A than on Bond B, for the same level of risk. Therefore, Bond A is relatively cheap (compared to Bond B), or Bond B is relatively expensive (compared to Bond A).
Bond 8 and Bond 7 are not comparable because they have different credit ratings but 5, 6 and 7 are of the same rating hence comparable, in which case the correct answer would be B. My thinking.
You’re correct.