I understand why the OAS is greater than the nominal spread and Z spread, but why is the nominal spread greater than the Z spread?
The Z-spread assumes a static interest rate environment in which the future interest rates are certain. The nominal spread should encompass also the risk resulting from interest rate volatility or am I mistaken? What do you think?
the Z-spread and Nominal spread should be approx. equal to each other assuming a flat yield curve. if the yield curve is not flat, the Z-spread should be larger that the nominal spread.
nominal spread just consider a particular T-bond YTM z-spread consider the term structure spot rate for a normal term structure, the steeper the slope, the higher deviation between z and nominal spread ( z is higher than nominal) however, reminded that putable bond is not normal, the price of a putable bond won’t drop/drop little when yield is high, so, the inverse relation between yield and price doesn’t apply as YTM of putable bond is lower than T-bond if other risk(credit, liquidity, etc) are the same( normally, T should have the lowest YTM but now there is a put effect), nominal spread only capture this spread z spread capture the whole term structure, so, putable bond short term rate > t-bond short term spot rate, but putable bond long term spot rate < t-bond long term spot rate this difference is somehow compensated in calculating z spread so it has a lower spread than nominal
z spread vs oas spread is confusing to me…i want to understand the concept as opposed to memorize what is the relationship for a callable bond vs a putable bond… but so tired…just did 3 hours of bonds and this really the only part i really cant seem to hammer down for some reason, i dont think it should be that hard
I’m still confused, can anyone else chime in?
I’m confused too. Where did you get this notion that for a putable bond “z spread < nominal spread < oas”? 1) The difference between the Z-spread and the nominal spread has nothing to do with the optionality of the bond, but the shape of the yield curve. Upward sloping yield curve means z-spread is higher than nominal spread, flat implies they are the same, downward sloping means nominal higher than z-spread, hump-shaped means anything can happen. 2) nominal spread and OAS are not directly comparable because one is calculated based on a yield curve (nominal) and the other over a spot rate curve (OAS). 3) Z-spread > OAS because if I have a putable bond trading at 105 with a yield of say 7% (z-spread), if it was not putable it would trade at 102 at a yield of 6.5% (OAS). That’s because I will pay more for a putable bond than a non-putable bond because that optionality accrues to me.
There’s a Book 6 Exam 2 AM session question (#110) the has a number of different spreads and you have to decide which bond is callable/putable. For the putable bond, the: Nominal Spread 202 bp Z Spread 201 bp OAS 226 bp For the callable bond, the: Nominal Spread 156 bp Z Spread 155 bp OAS 130 bp Edit: apparently the difference between the nom spread/z spread is irrelevant for this question?
" apparently the difference between the nom spread/z spread is irrelevant for this question?" Right. Just look at OAS and Z-spread and you’re done. Edit: BTW in my earlier post, I did not mean to imply that 7% was the z-spread and 6.5% was the OAS, but you can put all that together.
Thanks Joey! FI and deriviatives are killing me