# Nominal Spread - Term Structure

How come the nominal spread does not take into account the term structure of interest rates or impact of emnbedded options on the bonds? I thought the nominal spread merely adjusts the risk free rates to new interest rates that would make the new interest rates equal to the security price, and this could include the impact of embedded options and the interest rate term structure.

How does the option adjusted spread include the impact of the term structure of interest rates, but nomial spread does not?

The nominal spread is simply the difference between the YTM of the risky bond and the YTM of a risk-free bond of the same maturity.

The spread is added to only one point on the par curve: the maturity of that bond. The yields at all other maturities don’t matter.

The z-spread is added to every point on the risk-free spot curve, so it involves the entire (spot) yield curve.

The OAS is added to every point in a binomial interest rate tree, so it involves the entire (forward) yield curve.

I wrote an article on yield spreads that may be of some help here: http://financialexamhelp123.com/yield-spreads/

To build on your article, is the OAS is built off forward rates, and therefore spot rates. Since the spot rates comprise the term structure of interest rates, the OAS does in fact take into account the term structure of interest rates in its calculation?

The OAS is added to 1-period forward rates, not to spot rates.

There is a term structure of par rates, a term structure of spot rates, and a term structure of forward rates. The spot rates do not compose _ the _ term structure of interest rates; they compose _ a _ term structure of interest rates.

Yes, the OAS takes the term structure into account.

I just do not get how the nomial spread would not take into account the impact of embedded options.

Yes, the nomial spread is at one point in the curve, but couldn’t that one point in the yield curve take into account the value of the embedded options (relative to the yield of the benchmark at that point in time)?

As far as I can tell, nobody has said that the nominal spread fails to take embedded options into account.

To be clear: it does.

In one of the practice exams, Stalla claims that nominal spread ignore the impact of embedded options on bond prices and yields.

They’re mistaken.

The price and yield reflect everything about the bond, including the value of embedded options.