OAS for callable and putable bond

CFA Level II Fixed Income
#1

hi fellow members,

while practicing, i came across a question regarding if the interest rate volatility declines, what will be its impact on OAS for callable and putable bond for OAS spread.

As per my understanding, the callable bond value would have gone UP and hence OAS should decrease. for putable bond, value should go down and hence OAS should increase.

However the answer mentions OAS should inrease and decrease for callable and putable respectively.

I am confused now ! Can someone please explain the answer.

Regards

Sunil

#2

Did the question say that interest rate volatility declines, or did it say that the assumed interest rate volatility declines?

#3

Excerot from question "it is my understanding that as interest rate volatility declines, the OAS for callable bonds decreases while the OAS for putable bonds increases.”

its questiin 27 from fixed income in cfa practice questions.

#4

I think that it’s a sloppy question.

My suspicion is that he means the interest rate volatility assumed in a binomial, not the actual interest rate volatility in the market.

#5

For a callable, remember that:

Z-spread = OAS + Option Cost

Decreasing vol will decrease the option cost and therefore would drive OAS up as Z-spread is unchanged when vol changes.

That’s how I would think about it.