CFA Practice Question

There are 252 practice questions for this study session.

CFA Practice Question

The yield curve is flat. A bond with an OAS of 40 bp has a nominal spread of 175 bp. Which of the following is true?
A. The 175 basis points are all uncompensated risk to the investor.
B. The 40 basis points are uncompensated risk to the investor.
C. There may be 135 basis points that are uncompensated risk to the investor.
Explanation: The difference between the nominal spread and the OAS is the value of the option because the yield curve is flat. This is uncompensated risk to the investor. 175 - 40 = 135

User Contributed Comments 7

User Comment
Gigem I think that characterizing the value of the option as uncompensated risk to the investor is very confusing.

If the value of the option is 135 bps, then, in an effecient market, this value would be reflected in the price of the bond. Saying that 135 bps is uncompensated risk to the investor assumes that the value of the option is not priced in to the market price of the bond.
messi No Gigem. The price of the option has been already factored in when it says the OAS is ... and the norminal spread is .... The difference still exists even after we consider the price of the option.
saaythong It is compensation for credit risk above the treasury spot rate curve
MattNYC If the OAS compensates for Credit and Liquidity while the Nominal compensates for Credit, Liquidity and Option risk then the difference of 135 bp's must be due to the option risk.
rhardin I thought the difference between the Z-spread and OAS is the value of the option. NOT the difference between the nominal spread and OAS. So I got this wrong because I thought it was a trick. And I am still not clear as to why my thinking is incorrect.
MSRus When the yield is flat z-spread = nominal spread.
bruno5104 MSRus PERFECT!
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