CFAI Mock 2012 PM Q54

[zhoxu]

“OAS is particularly useful when analyzing bonds with embedded options. The value of OAS is that it is independent of assumptions such as volatility. It adjusts the bond’s cash flows for the embedded option when computing the spread to the benchmark interest rates.”
Is the statement correct regarding option-adjusted spread? The answer is “incorrect regarding volatity”.
But I think OAS is independant of volatility. OAS removes the spread of optionality, and it is the spread for a straight bond. A straight bond’s value is independant of volatility.
What is your idea?

 

[Topperharley]

If volatitlity goes up, the value of the option will increase and the OAS on a callable will go down…and vice versa.

 

[zhoxu]

z-spread = OAS + option cost. You assume z-spread does not change, so option cost goes up, OAS goes down.
But I think z-spread changes with volotilty.
From another point of view: value of callable = value of straight bond - value of option
if volatilty goes up, value of option goes up, I dont think value of straight bond changes with volaitity, so value of callable goes down. That means z-spread goes up.
The change of z-spread may offset the change of option cost, so OAS is not changed…

 

[cfa2014]

Would suggest you to read the CFAI curriculum (EOC problem-6).
OAS is a byproduct of the of the Biomial model which is dependet on certain assumptions which includes the Volatility assumption. So essentially, OAS is dependent on the volatility assumed in the bionomial model

 

[zhoxu]

cfa2014 wrote:
Would suggest you to read the CFAI curriculum (EOC problem-6).
OAS is a byproduct of the of the Biomial model which is dependet on certain assumptions which includes the Volatility assumption. So essentially, OAS is dependent on the volatility assumed in the bionomial model

yeah, thanks. I see the answer of EOC