Midterm Part D

Question 1

define Nominal Spread

Answer 1

Nominal Spread: measures the absolute spread between a Non-Treasury Bond and a Treasury Bond

Benchmark: YTM Curve
Compensates for: credit risk, liquidity risk, option risk

Question 2

Define Zero Volatility Spread

Answer 2

Zero Volatility Spread: is the spread that when added to the entire Treasury spot rate curve will make the present value of the cash flow from the non-Treasury bond equal to the non-Treasury bond’s price

Benchmark: Treasury Spot Rate Curve
Compensates for: credit risk, liquidity risk, option risk

Question 3

Define Option-Adjusted Spread

Answer 3

Option-Adjusted Spread (OAS): takes the dollar difference between the fair price (or value) and market price and converts it into a yield spread measure relative to a benchmark spot rate curve (not necessarily Treasury)

Benchmark: Treasury Spot Rate Curve
Compensates for: credit risk, liquidity risk