Spreads

Question 1

G-Spread

Answer 1

Credit-Risky Bond Yield − Gov’t Spot Rate

Reference Curve: Government spot curve

Measures credit risk above the risk-free government bond

Credit risk vs gov risk-free

Question 2

I-Spread

Answer 2

Credit-Risky Bond Yield − Swap Rate

Reference Curve: Swap curve (interpolated)

Measures credit risk vs interbank funding costs

“I” is for Interbank risk, not government → measured against SWAP curve, which reflects bank lending/funding cost.

Question 3

Swap Spread

Answer 3

Swap Rate − Gov’t Spot Rate

Reference Curve: Government spot curve

Measures liquidity/funding premium in swap market

🔁 “Swap vs Gov” = how much more banks are charging each other vs risk-free.
Swap = market-based rate; Gov = risk-free → difference = funding/credit risk in banking system.
Swap market funding premium

Question 4

Z-Spread

Answer 4

Spread added to each spot rate to price the bond

Reference curve: Entire spot curve (zero curve)

Measures total compensation for credit + liquidity risk (used in pricing)

Measures: Total credit + liquidity compensation

🧩 “Z = Zero Curve”
Think of it as a puzzle piece: Z-spread is added to every point on the spot curve (zero curve) → total spread needed to match bond price

Question 5

TED Spread

Answer 5

3-Mo LIBOR − 3-Mo Treasury Bill Rate

Reference Curve: T-Bill (risk-free)

Measures short-term credit risk between banks and gov securities

🧨 “TED = Trouble Emerging Daily”
LIBOR (bank borrowing rate) – T-bill (risk-free) = sign of bank credit stress
Higher TED = more fear in the interbank market!
Short-term bank credit risk

Question 6

LIBOR-OIS (MRR)

Answer 6

LIBOR − Overnight Indexed Swap Rate (OIS / MRR)

Reference Curve: OIS Rate

Measures interbank credit risk and stress in funding markets

Funding market stress