Hi David,
For the following question,
1. is there a relationship between Nominal spread and z-spread? is Nominal spread always larger than z-spread?
2. I think OAS should compare to the z-spread rather than Nominal spread of the comparable option free bond.
3. using OAS to decide relative value of bond, I wonder why we do not need to compare option cost is cheap or not? So even OAS is cheap, the option cost can be rich..
Thanks!
For the following question,
1. is there a relationship between Nominal spread and z-spread? is Nominal spread always larger than z-spread?
2. I think OAS should compare to the z-spread rather than Nominal spread of the comparable option free bond.
3. using OAS to decide relative value of bond, I wonder why we do not need to compare option cost is cheap or not? So even OAS is cheap, the option cost can be rich..
Thanks!
20. Two comparable (same credit rating, maturity, liquidity, rate) U.S. callable corporate bonds are being
analyzed by you. The following data is available for the nominal spread over the U.S. Treasury yield curve
and Z spread and option adjusted spread relative to the U.S. Treasury spot curve
X Y
Nominal spread 145 130
Z spread 120 115
OAS 100 105
The nominal spread on the comparable option free bonds in the market is 100 basis points. Which of the
following statements is correct?
a. X is undervalued.
b. Y is undervalued.
c. X and Y both are undervalued.
d. Neither X nor Y is undervalued.
Answer: b
a. Incorrect. The OAS of X bond is equal to the comparable option free bond while the option cost is
also higher than the Y bond.
b. Correct. The OAS of the bonds should be compared with the nominal spread on comparable option
free bonds. Bonds with higher OAS and low option cost are undervalued and should be bought.
c. Incorrect. X is not undervalued with a comparable OAS to the nominal spread of the option free
bonds.
d. Incorrect. Y is undervalued and should be bought.
Reference:
Bruce Tuckman, Fixed Income Securities, 2nd ed. (Hoboken: John Wiley & Sons, Inc., 2002).,
Chapter 21 – Mortgage-Backed Securities
analyzed by you. The following data is available for the nominal spread over the U.S. Treasury yield curve
and Z spread and option adjusted spread relative to the U.S. Treasury spot curve
X Y
Nominal spread 145 130
Z spread 120 115
OAS 100 105
The nominal spread on the comparable option free bonds in the market is 100 basis points. Which of the
following statements is correct?
a. X is undervalued.
b. Y is undervalued.
c. X and Y both are undervalued.
d. Neither X nor Y is undervalued.
Answer: b
a. Incorrect. The OAS of X bond is equal to the comparable option free bond while the option cost is
also higher than the Y bond.
b. Correct. The OAS of the bonds should be compared with the nominal spread on comparable option
free bonds. Bonds with higher OAS and low option cost are undervalued and should be bought.
c. Incorrect. X is not undervalued with a comparable OAS to the nominal spread of the option free
bonds.
d. Incorrect. Y is undervalued and should be bought.
Reference:
Bruce Tuckman, Fixed Income Securities, 2nd ed. (Hoboken: John Wiley & Sons, Inc., 2002).,
Chapter 21 – Mortgage-Backed Securities
