medium · Debt Capital Markets bond-instruments-structures

For a callable bond, how does the Option-Adjusted Spread (OAS) typically relate to the Z-spread, and what does the difference represent?

1. OAS is lower than the Z-spread; the difference is the cost of the embedded call option to the issuer.
2. OAS is higher than the Z-spread; the gap is the premium the investor pays for the call.
3. OAS falls below the Z-spread only when that bond happens to be trading at a steep market discount.
4. OAS and the Z-spread remain perfectly identical across every single bond except for those already in default.

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