Confused with putable bond OAS vs option free bond

@alta12 well if z spread is indeed -40bps and option cost is 25bps then OAS should be —> – 40bps – 25bps = -65bps
moving positive option cost over to the left side should make it negative, unless the typo you are referring to is actually -25bps to begin with then you are right on the (-40bps + 25bps)

The LAST PUSH GUYS, YOU CAN DO IT!!

no prob @alta12 !

i did CFAI’s AM yesterday, got distracted soooo badly.. didn’t manage to debrief it entirely. But I’ll be working on PM today, how about you?

OAS does not include option cost as it’s the “option removed spread”, so you don’t even have to talk about ‘put should be more expensive than option free’.

So by comparing a AAA corporate bond against a benchmark of say treasury bond, your corp bond should have a positive OAS and must also be more than the required rate, otherwise it would be considered overvalued.

Now back to your example, your comparable Z spread for a option free bond = -10bps
Z spread = OAS + option cost
– 10 bps = -10bps + 0 (since it’s option free)

The OAS for the putable bond = -15 bps (OAS is the option removed spread as mentioned above hence it can be compared with bonds without options)

-15bps < -10bps Therefore, the spread (excluding the option cost) on the putable bond is less than the option free bond with similar credit rating, liquidity and maturity.

Dont forget to memorize/understand the Relative OAS Valuation table that outlines the 3 benchmarks (Treasury, Sector, and Issuer-Specific) and remember that you always want to choose the bond with the highest OAS and lowest option cost. Doing CFA mock tomorrow. Interested to see the score relative to my Schweser exam scores.

I’m not too sure about the negative z-spread, maybe because it’s a putable option so they have a negative sign? (honestly i have not seen it in the syllabus)

Also, why would you have 2 different rates for option free bond? As far as i’m aware, option free bond would have the same spread for both Z and OAS.

Z-spread = OAS + option cost

Sorry couldn’t help much, maybe @sophie or @diya can look at this.

73% on both the AM and PM sections (mimicked the actual exam as much as possible). I found the PM to be much harder (esp. the first FRA section). I plan on spending M-W reviewing my weak areas (along with daily formula/note card review) and Th/Fri reviewing FRA/Equity/Ethics. Hoping to log 30 hours of study! Best of luck to you.