Woods is most likely resistant to the zero-volatility spread because the spread: A) only considers one path of interest rates, the current Treasury spot rate curve. B) does not indicate how much of the spread reflects the significant prepayment risk associated with MBS. C) fails to consider price risk, which is uncertainty regarding terminal cash flows. Your answer: B was incorrect. The correct answer was A) only considers one path of interest rates, the current Treasury spot rate curve. Zero-volatility spread is a commonly used measure of relative value for MBS and ABS. However, it only considers one path of interest rates, while OAS considers every spot rate along every interest rate path. (Study Session 15, LOS 59.a) How is B wrong! This is one of the main points about z-spreads!
I got this wrong in the Q-Bank and I agree with you. Dont see how B is wrong but A is correct as well. poor question.
mrgrey, can u at least see why A is correct? does it just mean that zspread only considers spread over one interest path (while oas over many)?
Z-Spread is the same spread applied uniformly to all points on the treasury spot rate curve - which makes the PV(CF) on the bond = Market Price of the bond. That is the very definition of the Z-Spread. So that is correct.
cpk123 Wrote: ------------------------------------------------------- > Z-Spread is the same spread applied uniformly to > all points on the treasury spot rate curve how is oas different? i thought it was applied to all spot rates as well. also, can you reason why choice B is wrong? thanks cpk youre the man.
The OAS applies to all paths of Spot rates, from what I understand. It is not only a single Spot rate. also z-spread applies only to the treasury spot rate- while the OAS could be either to the treasury, sector or issuer spot rate curve. I am totally not clear on this though.
I’m not sure about this myself however… Z-Spread can’t be used with bonds that have prepayment options because it doesn’t reflect the changing cash flows. Thus, it has only “one path”. OAS on the other hand allows for cash flow changes. Thus, OAS should be used for ABS/MBS or any bonds with options. I think the question should have specified what type of instrument was being evaluated…
cpk123 Wrote: ------------------------------------------------------- > The OAS applies to all paths of Spot rates, from > what I understand. It is not only a single Spot > rate. > This is what I thought too, but you wrote in an earlier post above, “Z-Spread is the same spread applied uniformly to all points on the treasury spot rate curve”. So doesnt it seem like z-spread is also a spread above all spot rates on the treasury curve? Also, in their answer they say z-spread can be used with ABS or MBS. Isn’t it true that z-spread CANNOT be used with MBS because of the interest rate path dependency of MBS?
The way I thought about it was that B is more relating to nominal spread, as we do not exactly know how much of the total compensation is for undertaking prepayments risks. A seems to be the pure unadulterated definition of Z-spread.
Did anyone manage to gain more clarity on this? Thanks!
wow dug this one up from the dead. rereading this now its a little more clear. A is definitely the definition of zspread. but what do we know about zspread? that it tells us what oas does for ONLY ONE PATH–the treasury spot rate curve. therefore while B is almost always true, when the path of interest rates is the spot rate curve, B would be false and zspread would in fact tell us how much of the spread reflects the significant prepayment risk. am i talking out of my ass?
Just an awful question.