Ned Jameson's ABS Purchase: Assumptions

B

The option-adjusted spread (OAS) is a measure used in fixed income analysis to evaluate the spread over a benchmark (usually a Treasury security) that compensates investors for credit risk, liquidity risk, and option risk associated with a bond or security. In this question, Ned Jameson is considering the purchase of a newly issued asset-backed security (ABS) and the broker/dealer offering the bond has provided an OAS value of 75 basis points (bps).

Let's go through each answer choice to determine which assumption can be made based on the given OAS value:

A. The OAS represents the investor's compensation for credit risk, liquidity risk, and option risk. This statement is generally true. The OAS represents the additional yield that investors require to compensate for the credit risk (risk of default), liquidity risk (ease of buying or selling the security), and option risk (the presence of embedded options in the security). Therefore, investors would demand a higher yield (spread) over the risk-free rate to compensate for these risks.

B. The bond is trading at a yield that is more than 75 bps higher than a Treasury security with a comparable maturity. This statement cannot be concluded based solely on the OAS value. The OAS represents the spread over the risk-free rate, but it does not directly provide information about the specific yield level of the bond. The yield of the bond will depend on various factors such as market conditions, supply and demand dynamics, and the credit quality of the security.

C. The implied cost of an option embedded in the security is always equal to the difference between the OAS and the Treasury spread. This statement is not necessarily true. While the OAS includes compensation for the option risk in the security, it does not mean that the implied cost of the option is equal to the difference between the OAS and the Treasury spread. The OAS incorporates the option risk, but the exact breakdown of the OAS into its components (credit risk, liquidity risk, and option risk) may vary depending on the specific security.

Therefore, based on the given information, the assumption that Jameson can make about this particular ABS is: A. The OAS represents the investor's compensation for credit risk, liquidity risk, and option risk.

It is important to note that the given question and answer choices are specific to the CFA® Level 1 exam and the provider "Test Prep." The information provided here is based on the general understanding of option-adjusted spread (OAS) and may not reflect the exact details of the exam question. It is always advisable to refer to the official study materials and guidelines provided by CFA Institute for accurate and up-to-date information.