This is a question that arose at work and is related to fixed income concepts that are covered on the CFA L1 curriculum. I am not pretty sure if this is the right place to ask it, so if not, apologies. Discussion might serve to those that are currently under L1 study.
I have a BB+ callable loan with 10 years to maturity and I’d like to know the value of the borrower’s callable option. I thought about searching for comparable bonds. That is, BB+ callable bonds, same maturity, similar issue dates, similar industry and region, same crncy. Since Bloomberg gives you the Z-spread and the OAS, would anyone agree that obtaining the value of those comparable bonds’ call options (Z spread - OAS) could be comparable with my BB+ callable loan?
P.S: I’m kind of new on this kind of fixed income analysis so if I’m making some error, suggestions are more than welcome.
Thanks!
I should think so.
What sort of range of values for the call options do you see in the Bloomberg numbers? Are they fairly similar, or all over the map?
Thank u s2000magician.
They’re all over the map…
I guess that is because the specific characteristics of each embedded call option are not known. I mean, when the callable option is really beneficial for the issuer, the Z spread will be much higher than the OAS, but if not that beneficial, the spread between OAS and Z spread will be narrow, am I right?
Other issue that is annoying me is that if the bond is neither callable nor putable (i.e.: paid at maturity), the OAS and the Z spread should be the same, shouldn’t they? I’m kind of confused since I’m getting different OAS and Z spreads for non-embedded option bonds from Bloomberg.
S2000magician, could you briefly explain the difference between the Nominal YTM spread, and the Z spread? I don’t see it very clear and I think is crucial for these fixed income concepts…
As far as I’ve understood, Nominal YTM spread is the difference between the YTM of a non-risk-free bond and the YTM of a risk-free bond. So, if my 10Y bond has a 5,00% YTM today, and the 10Y US Treasury bond has a 2,00% YTM today, the Nominal YTM Spread would be 3,00% (5% - 2%). I guess this spread will also depend on the benchmark you’re using as the risk-free YTM.
Now it comes the complexity for me. The Z spread is the spread over the “spot rate Treasury curve”? Could you explain this a bit? My understanding is that the “spot rate Treasury curve” plots different rates for different years, and with the YTM of the risk-free asset we are assuming that rate for the entire life of the asset. Then, if I have different risk-free benchmarks, how am I supposed to obtain the Z spread? I’d obtain one Z spread for each different risk-free rate, wouldn’t I?
Thank you sooo much and I hope I haven’t been too annoying!!
No, you’ve been just annoying enough.
Nominal spread is the difference between the YTM of the (risky) bond and the YTM of a risk-free bond with the same maturity. (So, yes: it depends on which risk-free bond you’re using as your benchmark.) It’s a spread at a single point on the _ par _ yield curve. It ignores the term structure of interest rates.
The Z-spread is the spread over the entire _ spot _ yield curve, so it explicitly includes the term structure of interest rates. (Note that the “Z” in “Z-spread” stands for “zero volatility”; i.e., a single spot yield curve, not a binomial tree.)
The OAS is a spread over the (spot) rates in a binomial interest rate tree, with the exercise of the option explicitly modeled in the tree.