Option-Adjusted Spread (OAS)

Definition of 'Option-Adjusted Spread (OAS)'


A measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Typically, an analyst would use the Treasury securities yield for the risk-free rate. The spread is added to the fixed-income security price to make the risk-free bond price the same as the bond.

Investopedia explains 'Option-Adjusted Spread (OAS)'




The option-adjusted spread helps investors compare a fixed-income security’s cash flows to reference rates, while also valuing embedded options against general market volatility. By separately analyzing the security's two components - the bond and the embedded option - analysts can determine whether the investment is worthwhile at a given price. The OAS method is more accurate than simply comparing a bond’s yield to maturity to a benchmark.

The OAS takes into account two types of volatility facing fixed-income investments with embedded options: changing interest rates (which affect all bonds) and prepayment risk. The shortfall of this approach is that estimates are based off of historical data, but are used in a forward-looking model. For example, prepayment is typically estimated from historical data, and does not take into account economic shifts or other changes that might occur in the future.

OAS is most likely to be used in the valuation of mortgage-backed securities. In this sense, the prepayment risk is the risk that the property owner may pay back the value of the mortgage before it is due. This risk increases as interest rates fall. A larger OAS implies a greater return for greater risks.


Filed Under: ,

comments powered by Disqus
Hot Definitions
  1. Quanto Swap

    A swap with varying combinations of interest rate, currency and equity swap features, where payments are based on the movement of two different countries' interest rates. This is also referred to as a differential or "diff" swap.
  2. Genuine Progress Indicator - GPI

    A metric used to measure the economic growth of a country. It is often considered as a replacement to the more well known gross domestic product (GDP) economic indicator. The GPI indicator takes everything the GDP uses into account, but also adds other figures that represent the cost of the negative effects related to economic activity (such as the cost of crime, cost of ozone depletion and cost of resource depletion, among others).
  3. Accelerated Share Repurchase - ASR

    A specific method by which corporations can repurchase outstanding shares of their stock. The accelerated share repurchase (ASR) is usually accomplished by the corporation purchasing shares of its stock from an investment bank. The investment bank borrows the shares from clients or share lenders and sells them to the company.
  4. Microeconomic Pricing Model

    A model of the way prices are set within a market for a given good. According to this model, prices are set based on the balance of supply and demand in the market. In general, profit incentives are said to resemble an "invisible hand" that guides competing participants to an equilibrium price. The demand curve in this model is determined by consumers attempting to maximize their utility, given their budget.
  5. Centralized Market

    A financial market structure that consists of having all orders routed to one central exchange with no other competing market. The quoted prices of the various securities listed on the exchange represent the only price that is available to investors seeking to buy or sell the specific asset.
  6. Balanced Investment Strategy

    A portfolio allocation and management method aimed at balancing risk and return. Such portfolios are generally divided equally between equities and fixed-income securities.
Trading Center