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Basic Question 7 of 13
What is the option cost imbedded in the Z-spread?
B. It is the difference between the spread earned in a constant interest rate environment and that earned with a volatility assumption on interest rates.
C. It is higher when interest rates are low or when the spot rates are relatively flat.
A. It is the difference between the spread earned in a constant interest rate environment and the nominal spread.
B. It is the difference between the spread earned in a constant interest rate environment and that earned with a volatility assumption on interest rates.
C. It is higher when interest rates are low or when the spot rates are relatively flat.
User Contributed Comments 8
| User | Comment |
|---|---|
| REITboy | Can someone pls explain? Thx! |
| chris54321 | No |
| joywind | you can regard option cost as value of option which increase when volatility increases. e.g. when volatility = 0, the int. rate is certain, then the option lose its value. |
| johntan1979 | Explanation is in the notes. Read them yourself. |
| davcer | ytm is fixed, term structure is variable that is about |
| robbiecow | "The reason that the option cost is measured in this way is as follows. In an environment in which interest rates are assumed not to change, the investor would earn the Z-spread. When future interest rates are uncertain, the spread is different because of the embedded option(s); the OAS reflects the spread after adjusting for this option. Therefore, the option cost is the difference between the spread that would be earned in a static interest rate environment (the Z-spread, or equivalently, the zero-volatility OAS) and the spread after adjusting for the option (the OAS)." |
| ashish100 | suck on this note johntan1979 you () |
| ashish100 | Sorry I was stressing out didn't mean it |
I used your notes and passed ... highly recommended!
Lauren
Learning Outcome Statements
explain the calculation and use of option-adjusted spreads;
explain how interest rate volatility affects option-adjusted spreads;
CFA® 2025 Level II Curriculum, Volume 4, Module 28.