CHAPTER 2 HIGHLIGHTED the importance of the embedded-option component of a bond. This chapter first focuses on how option value is described and then sets the stage for the quantitative methods employed in option-adjusted spread (OAS) analysis.
An option’s price is composed of two components, referred to as intrinsic value and time value.
Intrinsic value quantifies the profitability of exercising an option immediately, and is measured as the difference between the option’s strike price and the current market price of the underlying instrument. As an example, consider an investor, A, who owns both a bullet bond with a market price of 98 and a par (100) put on this bond that is currently exercisable. ...