CFA Practice Question

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CFA Practice Question

What is the option cost imbedded in the Z spread?

A. It is the difference between the spread earned in a constant interest rate environment and the nominal spread.
B. It is the difference between the spread earned in a constant interest rate environment and that earned with a volatility assumption regarding interest rates.
C. It is higher when interest rates are low, or when the spot rates are relatively flat.
Correct Answer: B

User Contributed Comments 8

User Comment
REITboy Can someone pls explain? Thx!
chris54321 No
joywind you can regard option cost as value of option which increase when volatility increases. e.g. when volatility = 0, the int. rate is certain, then the option lose its value.
johntan1979 Explanation is in the notes. Read them yourself.
davcer ytm is fixed, term structure is variable that is about
robbiecow "The reason that the option cost is measured in this way is as follows. In an environment in which interest rates are assumed not to change, the investor would earn the Z-spread. When future interest rates are uncertain, the spread is different because of the embedded option(s); the OAS reflects the spread after adjusting for this option. Therefore, the option cost is the difference between the spread that would be earned in a static interest rate environment (the Z-spread, or equivalently, the zero-volatility OAS) and the spread after adjusting for the option (the OAS)."
ashish100 suck on this note johntan1979 you ()
ashish100 Sorry I was stressing out didn't mean it
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