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Basic Question 6 of 13
Mike Weishot wants to purchase the Sysco bond shown below. Its rating has declined to BBB+, has a coupon of 11.40% and a price of 117.436. Mike is concerned about both the nominal spread and the Z spread and calculates both carefully. The comparable maturity Treasury has a YTM of 5% and the Sysco bond is currently providing bondholders a YTM of 5.822%. Given the Treasury data below and the information provided above, what is the difference between the zero-volatility spread and the nominal spread?
B. 49 Basis Points
C. 136 Basis Points
A. 17 Basis Points
B. 49 Basis Points
C. 136 Basis Points
User Contributed Comments 23
| User | Comment |
|---|---|
| chenyx | The nominal spread is simply the difference between the Bond's YTM and the YTM of the comparable Treasury. |
| chenyx | The Z spread is determined by comparing the purchase price with the discounted cash flows under each spread category. |
| chenyx | The Z spread occurs when the purchase price equals the discounted cash flows at the corresponding spread over the comparable Treasury. |
| haarlemmer | That's quite time consuming... |
| danlan | Why choose the column "Spread+99BP" instead of another column? |
| mtcfa | You have to choose the column where the sum of the discounted cash flows equals the price of the bond; $117.436. A good way to do this is choose the middle column. If it works out, then great; If the sum is too high, choose the column with the higher discount rate (lower sum of cash flows), or vice versa. |
| tengo | does anyone think it is odd that the z spread is bigger than the nominal spread and the yield curve is not inverted nor is the zero curve. |
| katybo | -z spread for short term issues has little difference with nominal spread -the steeper the spot rate curve the greater the difference -if the pricipal is repaid over time (MBS) the difference is greater |
| katybo | z spread compensates for credit, liquidity and any option risk (when compared to treasury bonds) |
| PASS0808 | Z spread is the interest rate premium that added to all spot rates on the treasury curve. If 99bp is z-spread, is"spread" refers to the spot rates on the treasury curve? |
| Lavay | No, the "spread" refers to bps over and above spot rates. |
| bmeisner | If you notice, the columns 24bps, 64bps and 99bps only allow for one answer because 24-82 = negative number, 64-82 = negative number, 99-82 = 17bps. I suspect this may help to eliminate useless answers on the test. |
| rana1970 | plz note that spot rates are upward sloping, so z-spread should be more than nominal spread(82bp), as other columns results in negative numbers, so me need to chosse 99, so as to have a positive z-spread fo 17(99-82). |
| weic08 | rana1970, good point, thx |
| actiger | How is that a good point? You should elaborate further. The question is asking for the difference, not necessarily (Z - N). You must have mentioned the convexity feature of bond prices! - Z-spread = parallel shift of the curved yield curve. - Nominal spread = parallel shift of the constant yield curve. - You should notice that the spot rates for the all years are below the constant yield of 5%. - Due to the convexity nature of bond price, the higher the rates, the higher the duration (i.e. slope of price change over rate change). - Therefore, larger changes (i.e. spreads) in lower rate are required to compensate for the same changes by the change in the higher yield. |
| actiger | I take it back: - The lower the rates, the higher the slope of price change. Therefore, if the rates are constantly below the yield of 5%, smaller spreads are required. - This contradicts the situation. Why did this happen? The correct Treasury yield is really 4.83% that will give the same present value as that computed by the spot rates. |
| samerthehammer | actiger please relax you are making all of us nervous. |
| Saxonomy | Lol, effing DITTO, samerthehammer. |
| 2014 | If the answer choices are 99-82 = 17 do we need to further calculate when other comparable answer choices and not appealing |
| johntan1979 | I agree with 2014. I solved this in less than 30 seconds. Look at the nominal spread... it's 5.822-5=0.822 or 82 basis points. Next, look at the z-spreads and the answers available. Only one answer gives you something close to the difference of nominal and z |
| johntan1979 | Or you can take the super long [at least 5 mins] way of adding up all the 3 cash flows... good luck! |
| gill15 | Dont add it up but know how to do it....just understand the logic of whats goin on here and your good to go... but johntan, i looked for the same thing....if that didnt work I would just skip this question..or copy the guy beside me.. |
| ldfrench | Yeah...F this |
Your review questions and global ranking system were so helpful.
Lina
Learning Outcome Statements
explain the calculation and use of option-adjusted spreads;
explain how interest rate volatility affects option-adjusted spreads;
CFA® 2025 Level II Curriculum, Volume 4, Module 28.