Z spread

CFA Level I
#1

I understand nominal spread but why do we have the z spread. The main reason for having z spread is term duration but I dont understand

please can someone explain

thanks

#2

Nominal Spread is just the spread between the yield on the bond and a treasury yield. It is not a good measue to use for Valuation. The Z spread is the spread you must add TO EACH SPOT RATE of the bechmark (usually treasury) to make the discounted cash flows of the bond you’re analyzing equal to its market price. The Z or zero volatility spread is a better measure than the YTM spread becasue it considers every point on the spot rate curve and if the spot rate curve is not flat(volatile) it provides a better measure of credit risk, liquidity risk and option cost (if applicable).

#3

Thanks mgum

#4

Mgurn: good job.

The nominal spread looks at one point on the (par) yield curve; the Z-spread looks at the entire (spot) yield curve from today to the maturity of the bond. The latter clearly holds more information.

#5

Thanks alot

#6

My pleasure.