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Question of the Week: Level 2 - Fixed Income

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:

 

Question of the Week: Level 2 - Fixed Income 7 votes

A. increase.
71% 5 votes
B. decrease.
14% 1 vote
C. remain unchanged.
14% 1 vote

Comments

  • MarkMeldrumMarkMeldrum OntarioPosts: 73 Associate
    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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