What Is an Option Adjusted Spread (OAS)?

What Is an Option Adjusted Spread (OAS)?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

An Option Adjusted Spread (OAS) is a financial measurement used in fixed income analysis. Fixed income analysis is the method financial experts use to assess and understand the details of returns that an investment will yield, particularly those relating to bonds and other debt instruments.

The OAS specifically is useful in comparing different fixed income securities, as it measures the difference in yield between a risk-free treasury bond and a riskier bond. It takes into account any possible changes in the cash flow caused by embedded options (features included in the bond that give either issuer or holder certain rights). Through this, it provides a benchmark that helps investors make decisions about purchasing bonds or other fixed income securities.

Related Questions

1. Why is the OAS Important?

The OAS is significant because it helps investors understand the level of risk involved in different fixed income securities. By comparing the yield between a risk-free bond and a riskier one, it offers a perspective on how attractive an investment may be.

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2. How is the OAS Calculated?

The OAS is typically calculated using complex financial models that include factors such as interest rates, redemption rules and the probability of the issuer exercising their options.

3. What Does a High Option Adjusted Spread Indicate?

A high OAS suggests a greater return but at a higher risk. This indicates that the investor would receive more returns on this bond compared to a risk-free bond, but it also implies a greater risk.

4. What Does a Low Option Adjusted Spread Indicate?

A low OAS suggests a lower return but with less risk. This indicates that the bond’s yield is closer to that of a risk-free bond, bringing less risk to the investor.

5. Can the OAS Be Negative?

Yes, in rare cases, the OAS can be negative. This typically happens if the bond’s yield is lower than that of a risk-free bond. This usually occurs when there are significant costs or risks associated with the options embedded in the bond. Investors usually avoid such bonds unless they have other compelling reasons for investment.