Option adjusted spread

[passcfaforsure]

Dear All:
OAS = spread - spread due to optionality
From this equation, if the the spread is high OAS is high. If the spread is high, it is not a good sign for the bond because the issuer have to compensate a lot of risks for the investor.
My question is that if OAS is high , is it good or bad for the investor ?
Thank you so much for your time.

 

[BMiller12]

I don’t necesarily think that a high spread is a bad/good sign, it’s all relative. It does’t really matter what the OAS (or the total interest rate for that matter) is so long as it’s appropriately compensating the investor for the inherent risks of the investment.
If, however, the required OAS is 50bps and the bond you purchase only pays 25bps, then you’re getting screwed (the bond is overvalued).
On the other hand, if you’re receiving more than what is required, the bond is cheap and you’re getting a deal.
So long as you’re being compensated for the risks, it really doesn’t matter how high the return is. PEG’s usually require 30-40%, which is much higher than a typical equity return. However, those investment’s are faaaaarrrr more risky, and therefore the risk-return relationship holds.
hope that addresses your question

 

[passcfaforsure]

Dear BMiller12:
Thank alots. I got it now.