Z Spread

Z Spread
CFA Institute does not endorse, promote or warrant the accuracy or quality of Finance Train. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
The problem with nominal spread is that it measures the spread at just one point on the yield curve. The z-spread solves this problem by considering the spot yield curve instead of the standard yield curve.
The z-spread, also known as the zero-volatility spread or the static spread, measures the spread that the investor will receive over the entire Treasury spot rate curve .
For the purpose of calculation, we start with an assumption for the z-spread. One takes the Treasury spot rates for each maturity, adds the z-spread to it, and uses this new rate as a discount rate for each maturity to price the bond. The correct z-spread is the one that makes the present value of cash flows equal to the price of the bond.
P = C 1 /(1+r 1 + z) + C 2 /(1+r 2 + z) 2 + C 3 /(1+r 3 + z) 3 ... T(1+r n + z) n
Note that the benchmark for calculating z-spread is the spot rate curve. Unlike nominal spread, the z-spread is spread over the entire Treasury spot rate curve.
The z-spread represents the additional risk the investor is taking in the form of credit risk, liquidity risk, and option risk.
In most cases, such as for the vanilla coupon paying bonds, the z-spread will only slightly diverge from the nominal spread. The difference mainly comes from the shape of the term structure and the bond characteristics. For example, the difference will be high for amortizing bonds for which the principal is repaid over time, bonds with high coupon, and when the yield curve is steep.
© 2021. Finance Train, All right reserverd.

More Articles
About

More Articles
About Us
Contact Us
Privacy Policy
Terms and Conditions

Carrieanne Larmore

Last Modified Date: August 23, 2022

The content you see here is paid for by the advertiser or content provider whose link you click on, and is recommended to you by Revcontent. As the leading platform for native advertising and content recommendation, Revcontent uses interest based targeting to select content that we think will be of particular interest to you. We encourage you to view your opt out options in Revcontent's Privacy Policy
Want your content to appear on sites like this? Increase Your Engagement Now!
Want to report this publisher's content as misinformation? Submit a Report

Login:

Forgot password?

Register:

About Us

Contact Us

Privacy Policy

Terms and Conditions

Copyright 2003 - 2022
Conjecture Corporation

Subscribe to our newsletter and learn something new every day.
A z-spread, or zero-volatility spread, is the spread where the security’s discounted cash flows equal its present value on a spot yield curve. Its primary purpose for investors or traders is to measure the spread that can be captured over the yield curve if the security is held until maturity. It is a useful tool for analyzing a non-treasury security, as it measures its credit, liquidity and option risks. Z-spreads can also be used as an economic indicator, where a negative z-spread often indicates a recession is on its way. Calculating the z-spread requires trial and error to find the correct spread, using basis points so that the present value of cash flows and the bond ’s price are the same.
Calculating the z-spread begins with adding basis points to each rate on the spot curve. For example, if the two-year rate on the spot curve is 4% with 50 basis points to be added, the rate would be 4.50%. An analyst can use this rate to calculate the present value of each cash flow and then add all of the cash flows together. The grand total of the cash flows should equal the security's price. If these two numbers do not match, recalculations will need to be made using different spreads, or basis points, until the present value of the cash flows is the same as the bond’s price.
Advantages of a z-spread include its ability to be independent of other points on the yield curve. Unlike the nominal spread, the z-spread is not dependent on only one point of the yield curve, which allows it to be trusted by investors or traders. While z-spreads are most commonly used by investors and traders, it is sometimes used as an indicator of the health of the economy. For example, a negative z-spread can point to a looming recession.
Measuring the z-spread is not limited to any one spot rate curve, so calculations should clearly indicate which spot rate curve was used. For instance, a z-spread can use the security issuer’s benchmark spot rate curve to measure liquidity and option risk of this particular instrument. Short-term and high-rated debt will have little or no difference between the z-spread and its asset- swap spread . If there is a difference between these two spreads for this type of debt, then it can be safe to assume that the market has not priced this security accurately and adjustments will be seen shortly.
Where can we find numerical examples of calculation of z-spread? How do you calculates the z-spread of a bond?
Just for your information: no trial and error needed.
1) Price the bond using the yield curve without a spread.
2) Calculate the implied YTM for the price calculated in number one.
3) Calculate the YTM that gives the market price.
4) The difference between the two YTMs is the Z spread
Credit must be given to my Professor Nabil Tahani.
My uncle is a trader and when he talks about what he does at work, many things are way over my head.

Are there software programs that help them figure out the yield curves, percentages and basis points? I think trying to manually trying to figure all of that out would take a long time and be extremely confusing.

Trading is usually a pretty fast paced world, and I think there would be all kinds of chart programs to help them with this information.

If a negative z-spread is the sign of a struggling economy, I would be curious to know whether we currently have a positive or negative z-spread.

With the economy being hit so hard lately, I can't imagine that there would be much of a positive z-spread right now.
Subscribe to our newsletter and learn something new every day.

See also

OAS

RTS

FVS

LV

VOV

BPV

Vvol

CSO

VaR

PVBP

Derivatives have increasingly become very important tools in finance over the last three decades. Many different types of derivatives are now traded actively on ... Browse Section By Letter

Remember to read our privacy policy before submission of your comments or any suggestions. Please keep comments relevant, respectful, and as much concise as possible. By commenting you are required to follow our community guidelines.

Comments

© 2022, Fincyclopedia, All Rights Reserved | Copyrights | Privacy Policy | Terms of Use | Disclaimer
By continuing to browse the site you are agreeing to our use of cookies . Yes, I agree
It stands for zero-volatility spread . The basis points which are added to the yield at each point on the spot treasury rate curve marking the receipt of a cash flow. As is normally the case, the spot treasury rate virtually constitutes no volatility . The yield plus this spread will make the price of a debt instrument equal to the present value of the cash flows generated by that instrument. Those cash flows will be discounted at the appropriate spread-adjusted yield.
An investor holding a bond to maturity would capture this spread over the entire yield curve (zero curve). The zero-volatility spread differs, in that sense, from the nominal spread as the nominal spread is categorically calculated on one point on the treasury yield curve. To the contrary, the zero-volatility spread uses a number of spot rates on the treasury yield curve. As such, each cash flow is discounted using its maturity and a respective spot rate for that maturity. This implies that a different zero-coupon rate is applied to each cash flow.
The zero-volatility spread is typically contrasted with the asset-swap spread to find out any discrepancies in the price of a fixed-income security . In general, those two spreads tend to converge in the cases of short-term debts and high credit-rating debts.
It is also known as a static spread .
Your email address will not be published.*
Save my name, email, and website in this browser for the next time I comment.

Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance
Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance
How to Calculate Spot Rate From Government Bonds
How to Calculate Yield & Years Until Maturity
How to Calculate Effective Duration
How to Calculate the Modified Duration of Your Bond Portfolio
How to Calculate the Maturity Premium for a Treasury Bond
How to Calculate Weighted Duration Bond
Copyright 2022 Leaf Group Ltd. / Leaf Group Media, All Rights Reserved.
While you don’t apply a Z-spread to your morning toast, it is a useful tool for pricing a bond. A bond’s yield is the annual interest it pays divided by its purchase price. When you plot yields against different maturity periods, you get a yield curve. When you compare two yield curves, you get a yield spread.
A zero-volatility spread can be defined as the amount of yield an investor can expect to receive from a non-treasury bond compared to a treasury bond.
The most basic yield curve plots the yields of Treasury bills, notes and bonds against their times until maturity. These yields are known as the Treasury spot rates. Treasury debt is considered risk-free, so all other bonds of a similar maturity yield more than does Treasury debt. For example, suppose the Treasury yield curve shows that a five-year Treasury note is yielding 4.5 percent if held to maturity. A five-year note from XYZ Corporation that yields 5.5 percent creates a spread of 1 percent, or 100 basis points, above the five-year Treasury spot rate.
The zero-volatility spread, or Z-spread, is the amount of yield you’ll receive from a non-Treasury bond above the yield for the same-maturity Treasury bond. Finding the Z-spread requires computing the present value of the cash flows – interest payments and repayment of principal – from a non-Treasury bond. The discount factor of a present value calculation determines the amount of interest you would earn if you received a future cash flow today, and held it until the actual cash flow date. The price of the bond is equal to the sum of the present values of its cash flows.
The Z-spread for a particular bond is static – the spread above the Treasury yield is the same for any period. For example, a Z-spread of 100 basis points means that each cash flow is discounted at a rate equal to the Treasury spot rate that applies to the cash-flow's period plus 100 basis points. In other words, the present value of the non-Treasury bond uses a different discount factor for each cash flow. The correct solution provides a constant, or static, spread above all the different Treasury yields from today until maturity. In practice, a computer program calculates this quickly.
Finding the correct Z-spread value takes trial and error. You plug in a spread and apply it to each different Treasury spot rate corresponding to each cash flow. For example, the Treasury curve might show the spot rates for one-year, three-year and five-year Treasury debt to be 3.15, 4.25 and 4.50 percent respectively. Adding a 50 basis point spread gives you yields of 3.65, 4.75 and 5.00 percent. You apply the 3.65 percent discount to the XYZ interest payment that is one year out.
Similarly, apply a 4.75 percent discount to the interest payment three years out and a 5.00 percent discount to the cash flows – interest and principal repayment – that will occur at maturity, five years out. In reality, you apply the appropriate discount rate to each semi-annual cash flow, not just to the three in this example. The result is a present value greater than the XYZ note’s current price. Only by repeating the process do you eventually find that a 100 basis point spread gives you the correct present value.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.

Very Older Granny Sleep Sex
Cindy Lesbian
Big Sexy Mature

Z Spread

Report Page