Z spread and OAS

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Jehanzaib Zafar

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if a callable bond has OAS of 75 basis points, this most likely suggests
1. bond has zero volatility of spread greater than 75 bps
2. implicit cost of call option is the bond’s nominal spread minus 75 bps
3. 75 bps represent investor compensation for credit, liquidity and volatility risks.
which one is right answer? i though 3 was the right answer but it is not.
 
z spread minus option cost = OAS.
z spread is the bond’s nominal spread over treasurys.
therefore the answer is 2
 
But since its a callable bond, option cost has to be positive, and therefore the z-spread is larger than 75bps?
 
I think the answer is 1- the z-spread is greater than the OAS for callable bonds
The implicit cost of the call option is the z-spread - OAS (not nominal spread)
 
i also think its 1….ugh, just want to get this thing over with!
 
Z-spread=OAS+option cost. since this is a callable bond then the option cost>0, thus z-spread>OAS - if the OAS is 75 then the z-spead must be >75 - correct answer 1.
 
JGK wrote:
Z-spread=OAS+option cost. since this is a callable bond then the option cost>0, thus z-spread>OAS - if the OAS is 75 then the z-spead must be >75 - correct answer 1.
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im confused with how this acts with a puttable bond…if you have a callable bond there is a call premium..which makes the OAS larger…and because of that, the z spread is larger…
for a puttable bond, since that is a benfit to the bondholder, is that bonds z-spread SMALLER than the z spread of a bond without the option? (everything else equal)
is it a negative oas spread?
 
k, so the z-spread=OAS+option cost.
for a callable bond, the option cost is >0 so the z-spread>OAS(for a callable bond the option cost is >0 because the callable bond is considered a benefit for the issuer so the bondholder needs a compensation in the form of option cost>0)
for a putable bond, the option cost is <0 so the z-spread<OAS(for a putable bond the option cost is <0 because the putable bond is considered a benefit for thebondholder, which makes the option cost<0 - the bondholder doesn’t have to be compensated as he already has an advantage by holding the put).
hope this helps,
 
See, this is what I’m afraid of. Reading comprehension. I didn’t even see the word “CALLABLE” until just now when I checked back on this link. Okay….must try and read and comprehend all the words on Saturday….
 
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