Introduction to Option-Adjusted Spread Analysis: Revised and Expanded Third Edition of the OAS Classic by Tom Windas

CHAPTER 1

FATAL FLAWS IN TRADITIONAL YIELD CALCULATIONS

TRADITIONAL YIELD CALCULATIONS compare the yield of a given bond to the yields of others with similar characteristics, including redemption date, credit rating of issuer, industry, and so forth, and also to a benchmark bond—one considered to be risk free. This is a fairly fruitful way to evaluate bonds with predictable redemption dates (bullet bonds). (It could be argued that other, newer methods are better, but that is the subject of another book.) Unfortunately, yield analysis is often applied to bonds with embedded options (nonbullet bonds). The results of this analysis can be quite unreliable because yield analysis does not account for uncertain redemption dates in a useful way.

This ...