Introduction to Option-Adjusted Spread Analysis: Revised and Expanded Third Edition of the OAS Classic by Tom Windas

FOREWORD

THIRTY YEARS AGO, bonds were quoted by coupon and yield to maturity, with the latter widely regarded as a de facto total return expectation.

As the bond world evolved, new types of bonds like callables, putables, and later, mortgage-backed securities were invented. This caused a dilemma for investors who were not exactly sure how to measure the risk and return of the new instruments. Or, as a fixed-income investor back in the 1980s might have put it: “Those bonds I purchased in the late 1970s sure paid a wonderfully high coupon, but just when rates went down, the bond was called away, and now I have to reinvest at much lower yields. I wish I could put a value on the option that the issuer retains, to redeem the bonds at par.”

The race ...