You have been presented with the option of investing in either Bond #1 or Bond #3 issued by the same UK corporation. Bond #1 and Bond #3 are equal in every respect (i.e. both are 3-year 6.5% coupon bonds), except that Bond #3 has a put option embedded in it. The following are the bonds Z-spreads over the UK term structure.

Bond #1: Z-spread = 4.65%

Bond #3: Z-spread = 4.05%

Your broker informs you that Bond #3 is a more attractive investment because, based on its option-adjusted spread (OAS), its option spread is .85% a. What are the option-adjusted spreads (OAS) for Bond #1 and Bond #3? Do you agree with your broker?

Suppose your broker informs you that the option-adjusted spreads (OAS) in part a. was computed using an assumed interest rate volatility of 10%, how would the OAS in part a. be affected if a 5% interest rate volatility is assumed?