A bond's yield-to-maturity can be separated into a benchmark and a spread.
Changes in benchmark rates (risk-free rate of return) capture macroeconomic factors that affect all bonds in the market: inflation, economic growth, foreign exchange rates, and monetary and fiscal policy.
Different spread measures:
Phil Deter was interested in purchasing a non-Treasury bond for 110.2950. Given the Treasury spot rate data below, and assuming that the non-Treasury bond had a coupon of 9.60%, what is the likely Z-spread that Phil will earn over the duration of his investment?
It is important to add all of the cash flows for each bond (discounted at the appropriate spot rate) and compare these to the purchase price by trial-and-error.
The bond with a spread of 143 Basis Points has a purchase price of 4.70 + 4.58 + 4.46 + 4.32 + 4.15 + 4.00 + 84.08 = 110.2950. Since this purchase price corresponds with the bond corresponding with Phil's interest, the appropriate spread must be 143 Basis Points.
|shasha: Two critical assumptions of the valuation model for OAS: 1) interest rate volatility, the higher, the lower OAS; 2) yield curve on which the benchmark is based on.|
|shasha: option cost is the difference between the spread earned in a constant interest rate environment and the spread earned with a volatility assumption on interest rates. so could we say high option cost means a big "cost" when interest volatility happened according to the valuation model's assumption?|
|shasha: well, may it be saying: Spread IS +xxx bp, not Spread PLUS xxx bp? anyway, not a big deal.|
|shasha: the head line of above table should be read: "spot rate + bp" instead of "spread + bp". and obviously it's semiannual bond.|
|reganbaha: The line on the table is correct. It is saying that the spread 'is' +143 bps, not spread +143 bps.|
|johntan1979: For the Phil Deter example, is adding up all the numbers to find the answer the only way? Drives me nuts! :(|