OAS again

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jaychou

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OAS compensate for option risk right? So does it mean that callable and putalbe bonds have the same OAS( which is positive)? When will OAS be negative?
 
Sorry: you’re both wrong.
OAS removes the option: it’s the spread that compensates the bondholder for everything other than the option risk.
The OAS is positive for risky bonds. It’s less than the Z-spread for callable bonds and greater than the Z-spread for puttable bonds.
The option value is positive for callables and negative for puttables, not the OAS.
Be careful!
 
Does the perspective you take on these matter?
For example you’ve got a bond with a OAS 130, yet a comparable bonds OAS is 150 (everything else identical).
To me, this would mean that the 130 is undervalued? You’re getting compensated 20 bp’s more with the 150? I know the answer is the opposite, but I can’t figure out why?
Thanks!
 
pass hungry wrote:Does the perspective you take on these matter?
For example you’ve got a bond with a OAS 130, yet a comparable bonds OAS is 150 (everything else identical).
To me, this would mean that the 130 is undervalued? You’re getting compensated 20 bp’s more with the 150? I know the answer is the opposite, but I can’t figure out why?
Thanks!
Click to expand...
If the OAS is 130bp instead of 150bp you’re earning a lower return than you should: the bond’s overpriced.
Higher yield = higher discount rate = lower price.
 
Got it. So I guess another assumption you’re making is that the price of the two bonds is the same.
I know obvious statement, but not so obvious in the context.
 
pass hungry wrote:
Does the perspective you take on these matter?
For example you’ve got a bond with a OAS 130, yet a comparable bonds OAS is 150 (everything else identical).
To me, this would mean that the 130 is undervalued? You’re getting compensated 20 bp’s more with the 150? I know the answer is the opposite, but I can’t figure out why?
Thanks!
Click to expand...
I was confused on this for a while. Just remember, OAS is a SPREAD measure pegged off of something else.
So if you are pegging the OAS off of something that yields 1%, and in your example there are two comparable bonds that have OAS’s of +1.3% and +1.5%, that would mean you are OVERPAYING for the +1.3% because you aren’t getting as much yield as you should be.
Not sure if that helps, but its how I think about it…and I’ve been able to answer every OAS question correctly.
 
pass hungry wrote:
Got it. So I guess another assumption you’re making is that the price of the two bonds is the same.
I know obvious statement, but not so obvious in the context.
Click to expand...
prices aren’t the same, thats what makes the OAS’s different in your example.
 
pass hungry wrote:Got it. So I guess another assumption you’re making is that the price of the two bonds is the same.
I know obvious statement, but not so obvious in the context.
Click to expand...
No. If bond A and bond B have essentially identical risks, they should have nearly identical OASs. If bond A pays a 4.5% coupon and bond B pays a 5.2% coupon, they shouldn’t have the same price. The two ideas are independent.
 
S2000magician wrote:
pass hungry wrote:Does the perspective you take on these matter?
For example you’ve got a bond with a OAS 130, yet a comparable bonds OAS is 150 (everything else identical).
To me, this would mean that the 130 is undervalued? You’re getting compensated 20 bp’s more with the 150? I know the answer is the opposite, but I can’t figure out why?
Thanks!
Click to expand...
If the OAS is 130bp instead of 150bp you’re earning a lower return than you should: the bond’s overpriced.
Higher yield = higher discount rate = lower price.
Click to expand...
I think i’m missing a lot of bits and pieces to OAS…
OAS is the additional spread/yield for having an embedded option?
Higher OAS is better because it means you are getting a higher yield?
Also applying it to a binomial tree you have to shift the curve instead of just adding the spread to all the spots? (if that’s correct I don’t really know what that means)
 
RayJay wrote:
[I think i’m missing a lot of bits and pieces to OAS…
OAS is the additional spread/yield for having REMOVED an embedded option.
Higher OAS is better because it means you are getting a higher yield and lower and cheaper prices relative to benchmark and sometimes required OAS.
Also applying it to a binomial tree you have to shift the curve instead of just adding the spread to all the spots? (if that’s correct I don’t really know what that means) You add (and keep adjusting) the same OAS to the each and every spot rate on the curve until you equalise the PV of the tree to current underlying asset price.
Click to expand...
 
RayJay wrote:
S2000magician wrote:
pass hungry wrote:Does the perspective you take on these matter?
For example you’ve got a bond with a OAS 130, yet a comparable bonds OAS is 150 (everything else identical).
To me, this would mean that the 130 is undervalued? You’re getting compensated 20 bp’s more with the 150? I know the answer is the opposite, but I can’t figure out why?
Thanks!
Click to expand...
If the OAS is 130bp instead of 150bp you’re earning a lower return than you should: the bond’s overpriced.
Higher yield = higher discount rate = lower price.
Click to expand...
I think i’m missing a lot of bits and pieces to OAS…
OAS is the additional spread/yield for having an embedded option?
Click to expand...
No.
OAS removes the effect of the option.
RayJay wrote:Higher OAS is better because it means you are getting a higher yield?
Click to expand...
Yes.
RayJay wrote:Also applying it to a binomial tree you have to shift the curve instead of just adding the spread to all the spots? (if that’s correct I don’t really know what that means)
Click to expand...
Shifting the curve and adding the same spread to each of the spots mean the same thing.
 
Yes, so you can compare it to the Z-spread of a comparable option-free bond which is the required OAS and make relative valuation.
 
Xander086 wrote:
Yes, so you can compare it to the Z-spread of a comparable option-free bond which is the required OAS and make relative valuation.
Click to expand...
I got this wrong on the mock. But glad I did, because forced me to learn those spreads better.
 
Z Spread - OAS = Cost of option.
OAS = Option removed spread, i.e. Spread EXCLUDING the option.
For identical bonds, you want to pay as little as possible for the option. You want to choose the bond with the higher OAS.
 
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