Could someone pls explain the reasoning behind the two: a) the longer the maturity, the wider the difference between zspread and nominal spread b) the flatter the yeild curve, the less the difference between zspread and nominal spread
assuming normal treasury yld curve, longer mty bonds will have greater ylds than shorter term bonds. this same concept holds true say for example corp bonds, but maganified due to additional risks such as default, liquidity, etc. compensation will have to inc further for longer term corporates as opposed to longer term treasuries, thus widening spreads as you go out the yld curve. flatter/steepr yld curve will make spreads between treasuries and corportates more pronounced. with flatter yld curve, less difference between short & long term yields, which will also equal to narrower (smaller) spreads.
But why does a steeper yield curve mean that spreads are greater? Is it because the lower short-term yield of treasury securities compared to long-term yields means that 1) right now the economy is not doing as well as it is expected to do in the long term 2) therefore the nominal spread (spread at maturity) is lower than the short-term spread should actually be? Is this the reason why Z-spread (a spread over the entire theoretical Treasury spot rate curve) must be greater, in order to “compensate” for the underestimation of the short-term spread?