Can someone help me out about the OAS?

CFA Level II Derivatives
#1

HELLO,

I’m suffering understanding the OAS.

First, I have learned that in the process of pricing the corporate bond, the spread that is added to forward rate would be upward-sloping. That means the first coupon would be discounted with 1+f(1)+s(1) and the second coupon would be discounted with 1+f(2)+s(2).

But in the example of the CALLABLE BOND, OAS is a spread in which option cost is eliminated from the Z-spread. And therefore OAS and Z-spread would be a curve that is parrallel to the US treasury. This does not accord with the fact that sector-specific spread is different on every period.

And also, I do not get why investors do calculate the OAS and how can they do that? I have understood as the following process; If the maket price of security is given, I can depict the Z-spread. And then using the bionomial tree or through Monte Carlo Simulation, get the value of the option and eliminate from the Z-spread. Is it correct?

I have so hard time understanding about it and so it would be SUPER THANKFUL who can answer to my question. Thkns.

#2

OAS removes the value of any embedded options, leaving a spread than allows you to compare callable, prepayable, putable, and straight bonds.

#3

Thanks a lot.

But i still have one more that has not been clarified.
Why does the investor have to compare the OAS instead of Z-Spread?
The market price is calculated with Z-spread(which means that the price includes the value of the option) and so I thought that its valuable to compare the Z-Spread of the callable, puttable and more.

Thanks for the answering again.

#4

The OAS removes the value of any embedded options, so it’s the spread on a straight bond. By comparing OASs, you’re comparing straight bonds to straight bonds: apples to apples. If you compare z-spreads, you’re potentially comparing, say, a callable bond to a putable bond: apples to oranges.

#5

Billion Thanks:))