CFA Level 1 - Fixed Income Investments
For example, take the spot curve and add 50 basis points to each rate on the curve. If the two year spot rate is 3%, the rate you would use to find the present value of that cash flow would be 3.50%. After you have calculated all of the present values for the cash flows, add them up and see whether they equal the bonds price. If they do, then you have found the Z-spread, if not, you have to go back to the drawing board and use a new spread until the present value of those cash flows equals the bonds price.
- Option-Adjusted Spread (OAS)
- Interest rate volatility is critical. The higher the volatility, the lower the OAS. Check this assumption when making comparisons.
- The OAS is a spread over the Treasury spot-rate curve or benchmark that is used in the analysis.
- As the name implies, the security's embedded option can change the cash flows and the value of the security should take this change in account. The difference between the OAS And the Z-spread is that the Z-spread doesn't take this into consideration.
- Option CostThis cost can be derived by calculating the difference between the OAS at the assumed interest rate or yield volatile and the Z-spread.