medium · FRM Part 1 Financial Markets and Products
In the context of mortgage-backed securities (MBS), if interest rates fall, the 'Option-Adjusted Spread' (OAS) will behave differently than the 'Z-spread' because:
- OAS applies only to Agency MBS that carry no credit risk.
- The OAS increases in value as prepayment speeds rise sharply.
- The OAS excludes the cost of the borrower's prepayment option.
- The Z-spread is always mathematically lower in value than the OAS itself.
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