Relationship btwn ASW spread, Z-spread, and CDS spread?

CFA General
#1

Hi, Are Asset Swap Spread, Z-Spread (based off a zero Libor curve) and CDS spread the same thing? If I see a difference between them than it’s entirely due to supply/demand and liquidity/illiquidity factors, correct? So if I see the ASW spread of a Conoco Phillips bond trading at 150 and the CDS spread trading at 130, I can do a basis trade where I buy the ASW and buy protection on the CDS to bet on a convergence in spread because arbitrage exists, correct? The arbitrage may be there for a reason such as the ASW market may be illiquid; therefore, the counterparty who is long Conoco risk will demand a spread of 150 for the bond in the ASW market. Thanks…

#2

NOT entirely due to supply/demand factors. Various structural diffs between a CDS and a bond that make for differences in the loss in the event of default. research “Par Equivalent Spread”.

#3

There’s a ton of differences in those things. The first big difference between the asset swap spread and the CDS spread is that the CDS spread is based on the bond issuer and the asset swap spread is based on a particular bond. “Arbitraging” one against the other is a cap structure trade and you should be pretty clear about the bet you are making (because the risk manager is absolutely going to ask you and if you say its a liquidity play or a pure arbitrage you are in for some derision).

#4

thanks Joey…i appreciate it.

#5

Thanks Joey, I was looking at valuing corporates via CDS so your answer helps shed some much needed light. Willy

#6

i guess you didn’t like my answer before on this when you asked months ago. again, currently there are more names trading at a higher spread for short term CDS protection then longer term CDS. (monolines come to mind)… If you lock in a 5 year CDS on a monoline at 300, and buy a ASW at 340 bps. If the credit curve was normal (upward sloping), then this may be consider a layup trade (with the exception of capital structure arb as joey mentioned, and liquidity). But most of these are trading inverted credit curve with their CDS. When you state ASW is 340 bps, you are saying the 340bps is OAS over swap curve, which is assuming a flat credit spread, however the credit curve CDS market is not flat, so you are not “beating the market”, in fact you may be paying the market. In the end, the trade works, but there might be a better one out there.

#7

Hmmmm… RB holding out on us.

#8

"But most of these are trading inverted credit curve with their CDS. When you state ASW is 340 bps, you are saying the 340bps is OAS over swap curve, which is assuming a flat credit spread, however the credit curve CDS market is not flat, so you are not “beating the market”, in fact you may be paying the market. " The only names that are trading with an inverted CDS curve from 0-5yr maturity are names that have elevated near-term event risk. I woiuldn’t say that “most” of the names out there have elevated near-term event risk. What you are seeing in CDS curves now a days is that the 2yr5yr curve is steepening and the 5yr10yr curve is flattening as investors are using the most liquid part of the CDS curve (5yr) to place risk averse bets. Let’s say that you see an ASW spread trading at 340 for a credit’s 5yr senior note, and you see the credit’s 5yr CDS trading at 300, and you see that the 0-5yr CDS curve is inverted, than you wouldn’t hesitate do a trade where you buy the asset swap and you buy CDS protection. The reason you wouldn’t hesitate is because a) the ASW spread is higher than CDS and it’s for a senior note and you get positive carry of +40bps and b) you get the benefit of rolling up the curve by being a 5yr protection buyer.