Session 16: Fixed Income: Analysis and Valuation
Reading 66: Yield Measures, Spot Rates, and Forward Rates
LOS g: Describe how the option-adjusted spread accounts for the option cost in a bond with an embedded option.
Kwagmyre Investments, Ltd., hold two bonds: a callable bond issued by Mudd Manufacturing Inc. and a putable bond issued by Precarious Builders. Both bonds have option adjusted spreads (OAS) of 135 basis points (bp). Kevin Grisly, a junior analyst at the firm, makes the following statements (each statement is independent). Apparently, Grisly could benefit from a CFA review course, because the only statement that could be accurate is:
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A) |
Given a nominal spread for Precarious Builders of 110 bp, the option cost is -25 bp. | |
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B) |
The spread over the spot rates for a Treasury security similar to Mudd's bond is 145 bp. | |
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C) |
The Z-spread for Mudd's bond is based on the YTM. | |
The “spread over the spot rates for a Treasury security similar to Mudd’s bond” refers to the Z-spread on the bond. For a callable bond, the OAS < Z-spread, so this could be a true statement because 135bp < 145 bp.
The other statements are false. The option cost is calculated using the OAS and the Z-spread, not the nominal spread. The static spread (or Z-spread) is the spread over each of the spot rates in a given Treasury term structure, not the spread over the Treasury’s YTM.
Remember the following option value relationships:
- For embedded short calls (e.g. callable bonds): option value > 0 (you receive compensation for writing the option to the issuer), and the OAS < Z-spread. In other words, you require more yield on the callable bond than for an option-free bond.
- For embedded long puts (e.g. putable bonds): option value < 0 (i.e., you must pay for the option), and the OAS > Z-spread. In other words, you require a lower yield on the putable bond than for an option-free bond.
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发表于 2011-3-30 15:50
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