CFA Level I · CFA Level I Exam · Yield and Yield Spread Measures for Fixed-Rate Bonds
A callable bond has a Z-spread of 1.60% and an option-adjusted spread (OAS) of 1.15%. The 0.45% difference is most likely:
The 0.45% gap between the Z-spread and OAS represents the value of the embedded call option held by the issuer, expressed in spread terms. OAS removes this option cost, leaving the spread for credit and liquidity risk, so OAS is lower than the Z-spread for a callable bond.
- Athe value of the call option to the issuer, expressed in yield spread termsCorrect
- Bthe additional compensation for the bond's liquidity risk
- Cthe value of the call option to the investor, expressed in yield spread terms
Explanation
OAS equals the Z-spread minus the option cost in spread terms. For a callable bond, the issuer holds the option, so investors demand extra spread, which is stripped out in OAS. The difference of 0.45% therefore represents the issuer's call option value, not liquidity or an investor option.
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