As per page 373 of the FIxed INcome volume, I understand that an option that is favorable to the issure such as a call option will have a larger yield spread. But I’m confused with the example given with Ginnie Mae because it shows that the option adjusted spread is lower than the yield spread. What can we infer from this example? (sorry for sounding like a textbook question there ) Your help is much appreciated!
Dear rockstar, Option adjusted spread is when we remove the impact of option cost from the yields. As you correctly mentioned, for a bond with call option yield spread should be larger. but they are larger as compared to a bond without any option. option adjusted spread for a bond with call option is calculated as follows: option adjuted spread= Yeild spread on the bond - option cost. Thus, the option adjusted spread is lower than the yeild spread. Option adjusted spread is actually the spread of a bond without any optiong attached to it and may vary with the valuation of option cost.