MBS

• An investor:
• wants to keep low interest rate sensitivity. (C1)
• wants to gain a substantially large OAS (option-adjusted spread) at a cheap price. (C2)
• is not concerned with credit risk.
• The term structure of interest rates is flat. (C3)

• (C1) A tranche with a low effective duration should be chosen.
• (C2) A cheap price → Low option cost, High OAS (*2)
• (C3) Z-spread = Nominal spread

MBS

MBS	Effective duration	OAS	Nominal spread	Option cost(*1)	OAS/Option cost
PAC Tranches
PT5	7.9 yrs	47 bps	62 bps	15 bps	3.13
Support Tranches
ST1	1.3 yrs (C1)	36 bps	60 bps	24 bps	1.50 (C2)
ST2	1.7 yrs (C1)	35 bps	69 bps	34 bps	1.03

(*1) Option cost = Z-spread - OAS; in this case, Z-spread = Nominal spread. (C3)
(*2) An investor who holds MBS with an embedded option does NOT actually receive an option cost (=premium). The investor gain only OAS (NOT z-spread) if option exercise is taken into consideration. So option costs should be lower, OAS should be higher.