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**CFA Practice Question**

Mike Weishot wants to purchase the Sysco bond shown below. Its rating has declined to BBB+ and it has a coupon of 11.40% and a price of 117.436. Mike is concerned about both the G spread and the Z spread and calculates both carefully. The comparable maturity Treasury bond has a YTM of 5% and the Sysco bond is currently providing bondholders with 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 G spread?

B. 49 basis points

C. 136 basis points

A. 17 basis points

B. 49 basis points

C. 136 basis points

Correct Answer: A

The Z spread equals 99 basis points and the G spread equals 82 basis points, for a difference of 17 basis points.

The Z spread is determined by comparing the price of 117.44 with the discounted cash flows under each spread category. The Z spread occurs when the purchase price equals the discounted cash flows at the corresponding spread over the comparable Treasury. The purchase price of 117.44 equals the cash flows of 5.59 + 5.46 + 5.33 + 5.17 + 4.99 + 4.81 + 86.08. These cash flows correspond with the Z spread of 99 basis points.

The G spread is simply the difference between the bond's YTM and the YTM of the comparable Treasury bond. In this example, the YTM of the Loupenny bond is 5.822% and the YTM for the comparable Treasury bond is 5%. The difference between the Loupenny YTM and Treasury YTM equals 82 basis points.

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**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 |