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AIWMI Exam CCRA-L2 Topic 8 Question 72 Discussion

Actual exam question for AIWMI's CCRA-L2 exam
Question #: 72
Topic #: 8
[All CCRA-L2 Questions]

Satish Dhawan, a veteran fixed income trader is conducting interviews for the post of a junior fixed income trader. He interviewed four candidates Adam, Balkrishnan, Catherine and Deepak and following are the answers to his questions.

Question 1: Tell something about Option Adjusted Spread

Adam: OAS is applicable only to bond which do not have any options attached to it. It is for the plain bonds.

Balkishna: In bonds with embedded options, AS reflects not only the credit risk but also reflects prepayment

risk over and above the benchmark.

Catherine: Sincespreads are calculated to know the level of credit risk in the bound, OAS is difference between in the Z spread and price of a call option for a callable bond.

Deepark: For callable bond OAS will be lower than Z Spread.

Question 2: This is a spread that must be added to the benchmark zero rate curve in a parallel shift so that the sum of the risky bond's discounted cash flows equals its current market price. Which Spread I am talking about?

Adam: Z Spread

Balkrishna: Nominal Spread

Catherine: Option Adjusted Spread

Deepark: Asset Swap Spread

Question 3: What do you know about Interpolated spread and yield spread?

Adam: Yield spread is the difference between the YTM of a risky bond and the YTM of an on-the-run treasury benchmark bond whose maturity is closest, but not identical to that of risky bond. Interpolated spread is the spread between the YTM of risky bond and the YTM of same maturity treasury benchmark, which is interpolated from the two nearest on-the-run treasury securities.

Balkrishna: Interpolated spread is preferred to yield spread because the latter has the maturity mismatch, which leads to error if the yield curve is not flat and the benchmark security changes over time, leading to inconsistency.

Catherine: Interpolated spread takes account the shape of the benchmark yield curve and therefore better than yield spread.

Deepak: Both Interpolated Spread and Yield Spread rely on YTM which suffers from drawbacks and inconsistencies such as the assumption of flat yield curve and reinvestment at YTM itself.

Then Satish gave following information related to the benchmark YTMs:

There is an 8.75% risky bond with a maturity of 2.75% year(s). Its current price is INR102.31, which corresponds to YTM of 8.52%. Compute Yield Spread from the information provided in the vignette:

Show Suggested Answer Hide Answer
Suggested Answer: C

Contribute your Thoughts:

Dustin
13 days ago
Hah, these candidates are really giving me a run for my money. Time to bring out the tough questions!
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Percy
15 days ago
Lower than Z-spread for callable bonds? Well, at least he's on the right track.
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Rosio
1 months ago
Hmm, calculating OAS as the difference between Z-spread and option price? That's some creative thinking right there.
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Shaun
16 days ago
Adam: OAS is applicable only to bond which do not have any options attached to it. It is for the plain bonds.
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Angelica
1 months ago
Both Interpolated Spread and Yield Spread rely on YTM which has drawbacks.
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Hermila
1 months ago
Interpolated spread considers the shape of the benchmark yield curve.
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Aron
1 months ago
Interpolated spread is preferred over yield spread due to maturity mismatch.
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Sabra
1 months ago
Prepayment risk? That's the key for callable bonds, bro. Gotta know your stuff.
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Julene
7 days ago
Balkishna: In bonds with embedded options, AS reflects not only the credit risk but also reflects prepayment risk over and above the benchmark.
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Cary
1 months ago
Adam: OAS is applicable only to bond which do not have any options attached to it. It is for the plain bonds.
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Aretha
1 months ago
Yield spread is the difference between the YTM of a risky bond and the YTM of an on-the-run treasury benchmark bond.
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Angelica
1 months ago
I am confident it is Asset Swap Spread.
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Hermila
1 months ago
I believe it is Option Adjusted Spread.
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Aron
1 months ago
I think it is Nominal Spread.
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Aretha
1 months ago
I am sure the spread that must be added to the benchmark zero rate curve is Z Spread.
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Angelica
2 months ago
For callable bond, OAS will be lower than Z Spread.
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Hermila
2 months ago
OAS is the difference between Z spread and price of a call option for a callable bond.
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Aron
2 months ago
I believe AS reflects credit risk and prepayment risk in bonds with embedded options.
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Joye
2 months ago
OAS is only for plain vanilla bonds? Seriously, this guy needs to read more about fixed income markets.
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Bok
9 days ago
Deepak: OAS is lower than Z Spread for callable bonds.
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Bok
11 days ago
Balkrishna: Yes, OAS is specific to bonds without embedded options.
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Aretha
2 months ago
I think Option Adjusted Spread is only for plain bonds.
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