After valuing a risky callable bond you determine that the market has priced-in an OAS of 55bps. You anticipate a credit upgrade for the bond. You feel an OAS of 25 bps is more appropriate. All else equal, the value of the call option should: A. increase.B. decrease.C. remain unchanged.

The correct answer is Option A. Lowering the OAS from 55bps to 25bps lowers all the forward rates in the interest rate tree by 30bps. This will result in higher bond values at each node increasing the probability of a call. This will increase the value of the call option.

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This topic has 1 reply, 1 voice, and was last updated Apr-206:34 pm by MarkMeldrum.

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- MarkMeldrum
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  24 Apr 2020 at 6:41 am
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  After valuing a risky callable bond you determine that the market has priced-in an OAS of 55bps. You anticipate a credit upgrade for the bond. You feel an OAS of 25 bps is more appropriate. All else equal, the value of the call option should:
  - A. increase.
  - B. decrease.
  - C. remain unchanged.
- MarkMeldrum
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  - Undecided
  27 Apr 2020 at 6:34 pm
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  The correct answer is Option A.
  
  Lowering the OAS from 55bps to 25bps lowers all the forward rates in the interest rate tree by 30bps. This will result in higher bond values at each node increasing the probability of a call. This will increase the value of the call option.
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