Z-Spread vs Nominal Spread - HELP PLEASE!

Hi, guys! Could you please explain me what is the difference between Z-Spread and Nominal Spread, rather than Nominal is at one point of time and Z-Spread is overtime? I don’t understand why for mortgage backed securities the difference between Z and Nominal spread is larger? WHY? I understand that both spreads represent the difference between Treasury yield and Security yield. How could they be different for the same security?

if i remember right z-spread is zero volatility spread, that is assuming there is not volatility, which is basically nominal spread adjusted for potential volatility (risk). because MBS carries a lot of reinvestment risk. Z-spread is higher than nominal spread because you add on a spread premium for risk. OAS is a z-spread adjusted for the value of the option provision. OAS is higher for callable bonds because call provision are valuable to bond issuers (less desirable for bond holders therefore considerred to be more risky) and lower for putable bonds ( more desirable less risky.) This is from my distant memory on this topic, i could be entirely wrong, can someone comfirm please?

Thank you! I think I get it! Z-spread = (Yield to maturity ovetrime calculated based on different (each period’s) Treasury spot rates) - Treasury yeild Nominal Yield =(Yield to maturity calculated based on the spot rate at maturity) - Treasury yeild

Think of the question you posted from the security value point of view. Nominal Spread as you said measures the spread at just 1 point in time (for just 1 maturity, say, 5 years) whereas Z-Spread measures a static spread added over the ENTIRE yield curve (for all maturities, say from year 1 to year 5). Now, lets compare a 5 year Zero Coupon Bond and a 5 year MBS. Assume the yield curve to be normal and discount rates are 3,4,5,6 & 7% for each year 1,2,3,4,5 respectively. A 5 year Zero Coupon Bond will be valued by discounting the par value (at the end of 5 years) by 7% (discount rate at year 5). Since just 1 discount rate is used, the value under both Nominal Spread & Z-Spread will not differ significantly. An MBS on the other hand will be valued by using 5 different rates (3,4,5,6 & 7% ; assuming 5 cash flows) under Z-Spread and just ONE rate under nominal spread (each of the cash flows will be discounted by 7%). Thus the difference in value will be much larger. The example isn’t complete but illustrates the concept. :slight_smile:

THANK YOU! Very cear :slight_smile: