Question

If the option adjusted spread is above the z spread, what type of bond are we looking at?

a) callable

b) puttable

c) government issued

Answer 1

Option "B" is correct.

The option is bought by the investor if the bond is putable and thus the benefit to the investor is brought down in the form of lower yields and higher bond prices– a lower option price as a proportion of the Z-Spread justifies it to reduce the benefit to the investor (look at the formula – a lower option price leads to a higher bond price and hence a lower yield). Thus the Z Spread has a lower option price and a higher OAS exists to adjust i.e., the option price is negative.