 # Schweser Fixed Income Question

Pg. 160 of the Schweser fixed income book: Bond A has an embedded option, a nominal yield spread to treasuries of 1.6%, a zero volatility spread of 1.4%, and an option-adjusted spread of 1.2%. Bond B is identical to Bond A except that it does not have the embedded option, has a nominal yield spread to treasuries of 1.4%, a zero vol spread of 1.3% and an option adjusted spread of 1.3%. The most likely option embedded in Bond A, and the bond that is the better value are: Embedded option Better value A. Put A B. Put B C. Call A D. Call B Schweser book says the answer is B and that the embedded option must be a put because the option value is negative. I think it’s D because the option value is positive by the following: Z spread = OAS + option cost For Bond A: 1.4% = 1.2% + option cost, option cost is 0.2% Since the the z-spread, which includes the cost of the option, is higher than the option adjusted spread, the option cost must be positive and the option is a call option, which makes sense because investors should demand a higher yield for a bond with an embedded call option as this is an advantage to the issuer. If the embedded option were a put, as schweser is claiming, the z spread should be less than the OAS, because this would benefit the investor resulting in a lower yield. Thoughts?