CFA Practice Question

There are 490 practice questions for this study session.

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?

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.

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
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