Z-spread

CFA Level II
#1

If interest rates are volatile, Z-spread is not appropriate to use to value bonds with embedded options since the Z-spread includes the cost of the option. - What does it mean by if interest rates are volatil? - Since Z-spread includes the cost of the option, isn’t it more useful in this case than OAS which removes the cost of the option?

#2

They go up, and down, and up, and down, and . . . .

The methods used to remove the option value presumably value the options fairly. By removing the value of the option(s), you’re left with a more stable spread measure that allows you to compare the value of bonds directly. The more noise being generated by volatile interest rates, the more you appreciate a (nearly) noise-free measure of comparative value.

#3

So for bonds with embedded options, which spread measure do we use?

#4

OAS

#5

thanks

#6

You’re welcome.