The definition of a Z-Spread is “the Z-spread is the basis point spread that would need to be added to the implied spot yield curve such that the discounted cash flows of the a bond are equal to its present value (its current market price).”
But shouldn’t a cash flow discounted at the spot price already equal its present value? Why is a spread needed for this to occur?
Because the spot rates used to discount those cash flows are based on treasury yields, or default free bonds, so a spread will need to be adjusted to reflect the credit risk associated with a corporate bond
I see. So does that mean the Z-Spread would be 0 for a treasury yield curve?
Yeah, exactly, hence why the Z-Spread relates to the Z ero Coupon Bond, or the treasury yield curve