cityboy

11. Which of the following statement is correct about the option adjusted spread ( OAS ): A. OAS is Z-Spread minus the option cost. B. OAS is the value of the embedded option. C. OAS is Z-spread plus the option cost.

Ans: A; The option-adjusted spread takes the option yield component out of the Z-spread measure. The option-adjusted spread is the spread to the Treasury spot rate curve that the bond would have if it were option-free. Therefore Z-spread – OAS = option cost in percent. A is the correct answer.

cityboy

12. The difference between Z-spread and nominal spread will most likely be the most significant for a: A. Treasury security with short maturity in a flat yield curve environment B. zero coupon Treasury security. C. mortgage-backed security in a steep upward-sloping yield curve environment

Ans: C; The difference between the Z-spread and the nominal spread is greater for issues in which the principal is repaid over time rather than only at maturity. Therefore B is incorrect. In addition, the difference between the Z-spread and the nominal spread is greater in a steep yield curve environment. Therefore, B is incorrect and C is the correct answer.

cityboy

13. All else being the same, the difference between the Z-spread and the nominal spread for a non-Treasury security will be greater when: A. maturity of the security is longer. B. yield curve is flatter. C. security has a bullet maturity rather than an amortizing structure.

Ans: A; A is correct because for short-term securities, the difference between the nominal spread (which does not account for the shape of the yield curve) and the Z-spread (the spread over the entire theoretical spot rate curve) is small. This difference grows with the maturity of the security and as the slope of the yield curve increases.

cityboy

14. A semiannual-pay bond is callable in five years at $106. The bond has an 8% coupon and 15 years to maturity. If the bond is currently trading at $98 today, the yield to call is closest to: A. 8.22% B. 8.49%. C. 9.48%.

Ans: C; Use the calculator to calculate yield to call: Time to call is 5 years and semi-annual pay=> N=10, 8% coupon and semi-annual pay=> PMT=4, The call price is $106 => FV=106, PV=-98 CPT -> 1/Y=4.7386 4.7386*2=9.48 Therefore the yield to call is 9.48%. C is the correct answer.

cityboy

15. A 10% annual coupon bond with 3 years to maturity is currently trading at $1,010. The bond is callable in one year at a call price of $1,008 and in two years at a call price of $1,005. The bond’s yield to worst most likely occurs when the bond is: A. held until maturity in 3 years. B. called in year 1. C. called in year 2.

Ans: A; The yield to worst for a callable bond is the lowest of the yields to call for each possible call date and the yield to maturity. The yield to call if the bond is called in one year is 10.45%, because 1,005=(100+1,010)/1.1045 The yield to call if the bond is called in two years is 10.09% , because 1,005=100/1.1009+(100+1,008)/1.10092 The yield to maturity of the bond is 9.80%, because 1,005=100/1.0980+100/1.0980 2+(100+1,000)/1.0980 2 The yield to worst is the lowest of these and occurs when the bond is held until maturity. Therefore A is the correct answer.