Zero Volatility Spread
Also known as the Z spread, static spread, basis point spread, yield curve spread, ZV spread
This represents a flat spread (or parallel shift) over the entire benchmark spot curve
The Z-spread uses the Spot Curve to calculate spread.
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 bond are equal to its current market price.
This calculation for Credit Spread is widely used in the Credit Default Swap market.
Why is it called Zero Volatility ?
The zero volatility is to make the distinction with the Option Adjusted Spread.
The OAS accounts for embedded options where cash flows depend on future interest rates
The reference to zero volatility is to emphasis that the future interest rates are based on todays yield curve and not dependent on interest rates calculated in the future.
In this regard there is zero volatility.
Example - Z Spread for a Corporate Bonds
Lets compare 2 different corporate bonds with the same maturity date but with different coupons
Company B has a 10 year, 5% coupon bond
The Z spread can be found using an iterative process
Lets start with a spread of 100 basis points (or 1%)
Add 1% to every point on the spot curve and calculate the bonds present value
Repeat this process until the present value is correct.
Important
A steeper yield curve leads to a higher z-spread given the same price.
The closer the maturity date, the closer the z-spread is to the nominal spread.
The spread assumes a fixed cash flow. To accommodate different cash flows you need to use the Option Adjusted Spread.
© 2024 Better Solutions Limited. All Rights Reserved. © 2024 Better Solutions Limited TopPrevNext