The schweser study guides are not very descriptive about Z spread and OAS. I am still confused after reading the topic two times. I will try to grab it from the CFAI Text books when I receive them. Were there any tough questions in the June exam from this area?
Not that I recall… Z spread is the percentage amount of yield that one should add to each cash flow’s spot rate. i.e. What fixed percentage yield increase should you add to each treasury spot rates in order to match the riskier bond’s price. It is more accurate than a nominal spread because it takes into account different spot rates at different points in the bond’s life. The OAS is simply the Z-spread adjusted as if there was no option embedded at all. So, you can now compare the yield of a option free bond with a bond that has embedded options. The OAS of a option bond is comparable with the Z-spread of an option-free bond.
Thanks for the simplified definition. It would have been easier to remember if Schweser had provided some graphs.
anyone knows what’s the difference of Treasury yield curve and Treasury spot rate curve?
Yield curve assumes that the discount rate to calculate the PV of all future cash flows is One single value known as YTM. Spot rate curve assumes that for each future cash flow there will be a different discount rate known as Spot rate.
OAS is model dependent, but it seems to me that all three yield measures must take into account the treasury spot rate curve in it’s calculation methodology…
nominal spread uses yield curve, rather than the treasury spot rate curve. so nominal spread will be equal to z spread only when the treasury spot rate curve is flat
Here is a question from Schweser Q-bank. Which of the following statements on spreads is FALSE: 1. The Z-spread will equal to the nominal spread if the term structure of interest rates is flat 2. The Z-spread may be used for bonds that contain call options. 3. The option-adjusted spread (OAS) is the difference between the Z-spread and the option cost. Answer: 2 The Z-spread is used for risky bonds that do NOT contain call options in an attempt to improve on the short comings of the nominal spread. The other statements are correct. ----------------------------------------------------------------------- I thought all three options are correct as I think the Z-spread can be used for bonds with options. Z-spread = Liquidity Risk + Credit Risk + Optionality Risk Isn’t that true?
msk, if you use z-spread for bonds with options, you’re including the cost of the options in the spread. OAS is the best one in this case, because it eliminates the impact of options and allows you to compare apples to apples, so to speak. I could be wrong, but I hope not since its just been 1 bloody week since the L1 exam!