Hi everyone, I’m getting those two confused. I completely understand the Option adjusted spread but I keep confusing the Zero volatiliy spread and the nominal spread. Any pointers? Thx
isnt it like saying the spread as if the bond didn’t have an option? So for a callable bond the OAS is less than zspread?
the z spread is the constant spread off of any point on the spot rate curve the nominal spread is the spread off any ONE point on the treasury yield curve
Don’t get the Z spread, what does the constant spread mean?
another question how the Z spread make the bond’s cash flows equal to the bond’s market price?
That’s a little better.
It’s not _ any _ one point; it’s specifically the maturity of the bond in question.
If the Z-spread were, say, 30bp for a 5-year bond, it means that you add 30bp to the 6-month (risk-free) spot rate, you add 30bp to the 1-year (risk-free) spot rate, you add 30bp to the 18-month spot rate, and so on up to the 5-year spot rate. You’re adding the same spread to every rate on the spot curve, so we say that the spread is constant.
You discount each cash flow on that 5-year bond using the adjusted spot rate for that maturity (i.e., the risk-free spot rate plus the Z-spread), then add up the present values of all of those cash flows. When you have the correct spread, the sum of the PVs of those cash flows will be the bond’s market price today.
I wrote an article on yield spreads that covers all of this in more detail: http://www.financialexamhelp123.com/yield-spreads/
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