What is Static Spread?

Static spread, also known as zero-volatility spread or Z-spread, is the constant yield spread added to all 澳洲幸运5官方开奖结果体彩网:spot rates on the Treasury curve to align the 澳洲幸运5官方开奖结果体彩网:present value (PV) of a bond's cash flows to it's current pr♌ic♋e.

Understanding Static Spread

The 澳洲幸运5官方开奖结果体彩网:yield spread is the difference in yields between two 澳洲幸运5官方开奖结果体彩网:yield curves. The yields on a yield curve which includes T-bills, T-notes, and T-bonds, are called the Treasury spot rates. The spread is the amount of yield that will be received from a non-Treasury bond above the yield for the same-maturity Treasury bond. Take the case of an investor comparing the Treasury yield curve to a corporation’s yield curve. The 澳洲幸运5官方开奖结果体彩网:interest rate on 2-year T-notes is 2.49% and the yield on the comparable 2-year corporate bond is 3.49%.꧙ The yield spread is༒ the difference between both rates, which is, 1% or 100 basis points.

A static, or constant, spread of 100 basis points means that adding 100 basis points to the Treasury spot rate that applies to the bond's cash flow (interest payments and 澳洲幸运5官方开奖结果体彩网:principal repayment) will make the price of the bond equal the present value of its cash flows. In other words, each bond cash flow received is 澳洲幸运5官方开奖结果体彩网:discounted at the 𝓡appropriate Treasury spot rate plus the static s💜pread.

Static spread is calculated by trial and error. An analyst or investor would have to try different numbers to figure out which number when added to the present value of the non-Treasury security's cash flows, discounted at the Treasury spot rate, will equal the price of the security in question.

For example, take the spot curve and add 50 basis points to each rate on the curve. If the two-year spot rate is 2.49%, the 澳洲幸运5官方开奖结果体彩网:discount rate you would use to find the present value of that cash flow would be 2.99% (calculated as 2.49% + 0.5%). After you have calculated all the present values for the cash flows, add them up and see whether they equal the bond's price. If they do, then you have found the static spread; if not, you have to go back to the drawing board and use a new spread until the present value of꧒ those cash flows equals the bond price.

The static spread differs from the 澳洲幸运5官方开奖结果体彩网:nominal spread in that the latter is calculated on one point on the Treasury yield curve, while the former is calculated using a number of spot rates on the curve. This translates to discounting each cash flow using its period to maturity and a spot rate for that maturity. As such, static spread is more accur𝔍ate than nominal spread. The only time where the static spread and the nominal spread would be equal is if the yield curve was perfectly flat.

Static or Z-spread calculations are frequently used in 澳洲幸运5官方开奖结果体彩网:mortgage-backed securities (MBS) and other bonds with 澳洲幸运5官方开奖结果体彩网:embedded options. An 澳洲幸运5官方开奖结果体彩网:option-adjusted spread (OAS) calculation, which is frequently used to value bonds with embedded options, is essentially a static spread c𒉰alculation based on multiple interest rate paths and the prepayment rates associated with each interest rate path. The static spread is also widely used in the 澳洲幸运5官方开奖结果体彩网:credit default swap (CDS) market as a m🍰easure of credit spread that is relatively insensi💎tive to the particulars of specific corporate or government bonds.