INVESTORS USE option-adjusted spread (OAS) analysis to first measure the value inherent in a bond’s cash flows and embedded options and then to compare the results to market reference levels.
This comparative method makes it possible to see how much yield results from what kind of risk. A given bond may pay higher yield for a combination of reasons: there could be increased risk of default or increased uncertainty of cash flows. The bond may have a complex structure or a small market of ready buyers and sellers. The challenge facing those performing valuation of different bonds is to isolate components of risk and ensure adequate compensation for the risk taken.
If different elements of risk and uncertainty can ...

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