price of different MBS tranches

CFA Level II
#21

for given duration and Z-spread, lower OAS high price?

#22

maratikus Wrote: ------------------------------------------------------- > definitely D > > mwvt, I like what you made up but I wonder if > there is a standard way. That may be something to figure out after the exam. My guess is that the CFAI will test the concept and give an example similar to what Nib did (where you can just eyeball it).

#23

Answer is D: A higher OAS indicates a larger risk-adjusted spread, which leads to a lower relative price. The implied cost of the embedded option in a security with a call feature is the option cost, so a buyer would prefer a lower cost.

#24

Niblita, thanks for good questions. mwvt, you are correct. the exam is going to be conceptual. overanalyzing one problem might hurt overall studying.

#25

One last question: Can this be related to a callable bond in regards to option cost? V(callable)=V(noncallable)-V(call)

#26

yes: OAS = Z-spread - option cost

#27

OAS(credit risk, liquidity risk) = Z(credit risk, liquidity risk, optionality risk) - optionality

#28

I got that but I am confused as to the option cost. If we have a low option cost it would imply a higher price…but we are looking for lower priced securities. I guess that is why we have to use a relative measure huh? V(callable)=V(noncallable)-V(call)

#29

for given duration and Z spread, lower option cost means highter OAS and lower price?

#30

low option cost would lead to higher OAS (which is a spread) so this would lead to a lower value of the callable bond.

#31

No, you want a lower option cost and a higher OAS. Edit: I think. Does one lead to another I have no idea.

#32

There is an example from the Fixed Income CFAI Book: Tranch--------OAS---------Z-Spread--------Nominal Spread--------Effective Duration PAC1---------50bps---------60bps-------------68bps-----------------------1.5 years PAC2---------70bps---------80bps-------------85bps-----------------------3.0 years PAC3---------30bps--------120bps-------------128bps----------------------5.0 years PAC II A------80bps---------150bps------------156bps---------------------4.0 years Support 1----35bps---------165bps------------178bps---------------------11.0 years Which PAC tranch is likely to be the MOST expensive in terms of option cost? A. PAC1 B. PAC2 C. PAC3 D. PAC IIA

#33

C.

#34

C

#35

Agree with mwvt9.

#36

C I guess.

#37

I haven’t found anything “official” as far as comparisons go, from what I can tell it’s all relative because the OAS computed depends on which valuation model and forward rates are chosen. For a given OAS, a higher volatility assumption gives a lower price and you always want a higher price to sell at. If the OAS quotes are the same then the best bid is the one with the lowest volatility assumption. if you have 2 bids: Dude i 10 @ 18% Dude ii 10 @ 24% You always want the lowest OAS per measure of volatility, So Dude i is the best bid because this is the highest price at which you can sell the MBS. mwvt9 is right, this stuff hurts the head

#38

Actually the highest is ‘Support 1’ with 130, but it’s not listed in the option, so the 2nd highest is 90 = C?

#39

C for sure

#40

Answer: C “The lower the OAS, the lower the return offered by the security. A lower return might be acceptable if effective duration is less. Of the five listed tranches, PAC3 has the lowest OAS (lowest return), yet its risk (Effective duration) is higher than all but the support tranch. Note that the support tranche is not an available answer. Furthermore, the option cost of PAC3 is 90 which exceeds the option cost for the other choices”