What is the 'OptionAdjusted Spread (OAS)'
The optionadjusted spread (OAS) is the measurement of the spread of a fixedincome security rate and the riskfree rate of return, which is adjusted to take into account an embedded option. Typically, an analyst would use the Treasury securities yield for the riskfree rate. The spread is added to the fixedincome security price to make the riskfree bond price the same as the bond.
BREAKING DOWN 'OptionAdjusted Spread (OAS)'
The optionadjusted spread helps investors compare a fixedincome 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 fixedincome 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 forwardlooking 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 mortgagebacked 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.

Prepayment Risk
The risk associated with the early unscheduled return of principal ... 
Embedded Option
A provision in a security that is an inseparable part of the ... 
Spread
1. The difference between the bid and the ask price of a security ... 
Credit Spread
1. The spread between Treasury securities and nonTreasury securities ... 
RiskFree Rate Of Return
The theoretical rate of return of an investment with zero risk. ... 
Static Spread
The constant yield spread which when added to the point on the ...

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