Prof, I would like to take this opportunity to thank you for your videos. No matter what happens on the exam, your videos have been of immense help in my L1 prep. Without your videos, I wouldn't have been able to cover even 50% of the subject matter. I watched almost all of your videos at 1.5-2x speed. I'm no man of means and couldn't have been able to afford any of those expensive prep options out there. There are very few people in the world I feel so indebted to. I wish I had teachers like you in my early life. It is said that it is the teacher who makes the man. Now I see why they say that. I'm sure hundreds, if not thousands, of CFA candidates around the world would share the sentiment. Your knowledge of the subject matter is comprehensive and your pedagogy is immaculate. Thank you.
Just wonderful, been searching for "option best" for a while now, and I think this has helped. Ever heard of - Winoorfa Option Olegroson - (do a search on google ) ? Ive heard some amazing things about it and my mate got great success with it.
Dr. Meldrum: Please add this video as a seminar on your site for L2 Fixed Income Reading 34 - Valuation and Analysis of Bonds with Embedded Options - LOS - G & H . This will help you save time on answering hundreds of questions about this topic.
can we say oas = z spread - option cost. with the option cost being positive for a callable bond and negative for a putable bond. and the option cost being directly proportional to volatility.
Why is call option cost positive (and vice versa)? Are we looking at it from the perspective of the bond issuer and not the investor? If so, it makes sense.
hi mark, is my understanding correct if i say the OAS is used to find the value of straight bond (we essentially want to remove option value in the pricing). so if we want to price a callable/putable bond, we can use z-spread?
7:47 why you subtracting call option from OAS? Shouldn't it be the other way around? If you then say it's Z-spread = OAS(0) - Call. But a few moments earlier you said that assuming zero volatility, OAS(0)=Z-spread. Why to subtract worthless call option?
the option price is directly related to the volatility, and more volatile the underlying asset is , the more valuable the option is, we can use this formula OAS =z-spread +option price , and explain the negative callable option price that, because that's a right for issuer , benefit the issuer, that means it's bad for the investor , therefor it should be negative . meanwhile for putable bond ,which benefit the investor , so it's positive.
The underlying asset you refer to with reference to the volatility is not an asset, it is interest rates. Using the formula you mention does not quite capture the nuance of what is happening. A z-spread compensates us for the risk we assume. As volatility of interest rates increase, the OAS decreases for callable bonds. This is saying that the amount we get paid for the risk of the issuer with respect to just the underlying straight bond portion gets smaller. We are in essence being paid less and less for risk (albeit, the price volatility of the bond decreases with interest rate decreases)
Thank you mark for your valuable time. Now, OAS concept is much clearer but still the formula (Z-spread = OAS - call value ) didn't make a logic for me because Z-spread and OAS is measured in % and call value in $. How can we add these together? By the way I got the intuition that when volatility increases, call value increases and OAS decreases.
Mark Meldrum Yes, OAS and Z-spread are measured in bps and call value in $ so how can we add these together to for the equation Z-spread=OAS -call value
Price out a bond at 4%. Now price out a bond at 4.2%. You should be able to find the difference in $. So you can find the $ value of 20 bps. You can translate bps in to $. Thus you can also translate $ into bps. You look, but you do not see, young Jedi!
Prof, I would like to take this opportunity to thank you for your videos. No matter what happens on the exam, your videos have been of immense help in my L1 prep. Without your videos, I wouldn't have been able to cover even 50% of the subject matter. I watched almost all of your videos at 1.5-2x speed.
I'm no man of means and couldn't have been able to afford any of those expensive prep options out there. There are very few people in the world I feel so indebted to. I wish I had teachers like you in my early life. It is said that it is the teacher who makes the man. Now I see why they say that. I'm sure hundreds, if not thousands, of CFA candidates around the world would share the sentiment.
Your knowledge of the subject matter is comprehensive and your pedagogy is immaculate.
Thank you.
Hear! Hear!
Just wonderful, been searching for "option best" for a while now, and I think this has helped. Ever heard of - Winoorfa Option Olegroson - (do a search on google ) ? Ive heard some amazing things about it and my mate got great success with it.
Dr. Meldrum:
Please add this video as a seminar on your site for L2 Fixed Income Reading 34 - Valuation and Analysis of Bonds with Embedded Options - LOS - G & H . This will help you save time on answering hundreds of questions about this topic.
Only youtube video, explaining the difference between z spread and oas. Thank you, Professor.
Great explanation, i'm using to understand the mess we are in currently
can we say oas = z spread - option cost. with the option cost being positive for a callable bond and negative for a putable bond. and the option cost being directly proportional to volatility.
YES!
bingo thanks
Delayed response, but thanks for this summary. This cleared it up for me.
Why is call option cost positive (and vice versa)? Are we looking at it from the perspective of the bond issuer and not the investor? If so, it makes sense.
hi mark, is my understanding correct if i say the OAS is used to find the value of straight bond (we essentially want to remove option value in the pricing). so if we want to price a callable/putable bond, we can use z-spread?
very enlightening, thank you Sir.
7:47 why you subtracting call option from OAS? Shouldn't it be the other way around?
If you then say it's Z-spread = OAS(0) - Call. But a few moments earlier you said that assuming zero volatility, OAS(0)=Z-spread. Why to subtract worthless call option?
Its a short call. So OAS - (- call) = OAS + call
Couldn't you re-arrange the formula and also say (Z-Spread + C = OAS) so as volatility increases so does OAS? Correct? Thank you
the option price is directly related to the volatility, and more volatile the underlying asset is , the more valuable the option is, we can use this formula OAS =z-spread +option price , and explain the negative callable option price that, because that's a right for issuer , benefit the issuer, that means it's bad for the investor , therefor it should be negative . meanwhile for putable bond ,which benefit the investor , so it's positive.
The underlying asset you refer to with reference to the volatility is not an asset, it is interest rates. Using the formula you mention does not quite capture the nuance of what is happening. A z-spread compensates us for the risk we assume. As volatility of interest rates increase, the OAS decreases for callable bonds. This is saying that the amount we get paid for the risk of the issuer with respect to just the underlying straight bond portion gets smaller. We are in essence being paid less and less for risk (albeit, the price volatility of the bond decreases with interest rate decreases)
Thank you mark for your valuable time. Now, OAS concept is much clearer but still the formula (Z-spread = OAS - call value ) didn't make a logic for me because Z-spread and OAS is measured in % and call value in $. How can we add these together? By the way I got the intuition that when volatility increases, call value increases and OAS decreases.
No. OAS and Z-spread are measured in bps.
Mark Meldrum Yes, OAS and Z-spread are measured in bps and call value in $ so how can we add these together to for the equation Z-spread=OAS -call value
Price out a bond at 4%. Now price out a bond at 4.2%. You should be able to find the difference in $. So you can find the $ value of 20 bps. You can translate bps in to $. Thus you can also translate $ into bps. You look, but you do not see, young Jedi!
Mark Meldrum oohh! Got it That' was a silly question
burhhhh i am STILL confused
woh, Mark on normal speed, after 5 months of 1.5x, sounds weird.
Thanks mark, that was really helpful!
Thank you
legend
thanksss