Hi, If the word spread relates to what you add to the intretest rate for a given time period treasury cash flow, why oh why, is the OAS less than the Z spread? In my head, If say for Option-adjusted value you want discount more savagely than would otherwise be the case. Surely if you’re reviewing multiple interest rate paths under Monte Carlo, you’re going discount more than if calcs were based just on the treasury spot rate curve. Can you help explain this to me? Thanks
Hang on a minute, under the above Z spread minus OAS would be a negative figure. Is it that pesky negative sign that represents the options’s cost?
Whoops wrong thread! Search is my friend… JD’s response in a prior thread: ‘Reverse that. A callable bond trades at a Z-spread of 8% (wow) and without the option it would trade at an OAS of 6%’ My interpritation is therefore: Because without the call option, you’d happily pay more (i.e. cash flows discounted less
So if Zspread = 9 and OAS is say = 7 then your option cost is 2. The Zspread includes the cost of the the embedded option, whereas the OAS took out “option risk”. Think of OAS as the spread that is adjusted (removed option risk out). Hope this helps!
Yeah I was completely neglecting the fact that the market price is what it is and isn’t being changed! It’s staying the same, and it’s the PVs of the cash flow values that are adjusted (downwards).