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Basic Question 1 of 13
For a callable bond, the higher the assumed volatility of interest rates, the ______ the option adjusted spread.
B. lower
C. there is no relationship between the two measures.
A. higher
B. lower
C. there is no relationship between the two measures.
User Contributed Comments 12
| User | Comment |
|---|---|
| sharapov | option price is excluded from OAS, so there should be no relation |
| tengo | I agree with sharapov but I think we are supposed to assume "all else are equal" - then the oas would shrink. |
| katybo | OAS will depend on the volatility assumption. The higher the volatility the lower the OAS. |
| danlan2 | This is for callable and not putable bond, right? |
| ehc0791 | holding the price constant, the higher the volatility, the lower the oas (= Z-spread - option cost) |
| bmeisner | This is only for a callable bond. Higher volatility always increses the embedded option value. If the investor owns the option (e.g. putable) then the OAS is higher for higher volatility, meaning the bond is cheaper because it offers a higher option adjusted yield. |
| giroth | Option cost = Z-Spread - OAS. Higher vol --> Increased Option Cost, which reduces OAS |
| Allen88 | Thanks giroth |
| chris54321 | u are gona pass fo sho giroth |
| davidt876 | worth noting the difference between the treatment of terms option cost and option value at this point: option value: callable bond value = straight bond value - call option value putable bond value = straight bond value + put option value option cost: embedded option bond value = straight bond value - option cost where put option cost < 0 (and therefore always increases value) and call option cost > 0 (and therefore always decreases value) |
| davidt876 | my problem with this question is that as volatility increases the option cost increases and the value of the callable bond decreases. therefore the calculated z-spread would increase - right? so if OAS = z-spread - option cost; and the answer is that OAS goes lower, then we're assuming the option cost increases more than the z-spread? but that doesn't make sense because as volatility increases the straight bond yields are (according to the notes) unaffected, while callable bond yields increase. if OAS is supposed to remove the effect of the embedded option, then surely it has to increase as the gap between the two yields increases? am i tripping? |
| davidt876 | yeaaa i was trippin. found this explanation online: "The Z-spread is your compensation when interest rates are stable… hence, the term, zero-volatility spread. So if volatility goes up, Z-spread won’t budge. Meaning OAS must decrease." |
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Learning Outcome Statements
explain the calculation and use of option-adjusted spreads;
explain how interest rate volatility affects option-adjusted spreads;
CFA® 2024 Level II Curriculum, Volume 4, Module 30.