Nominal Spread, or the nominal yield spread, is the most simple yield spread for non-Treasury bonds. Nominal spread measures the difference between the yield of a bond and the yield to maturity of a similar maturity Treasury bond. Consider the following two 10-year bonds:
- A Treasury bond having a YTM of 6.5%
- A non-Treasury bond having a YTM of 8%
Nominal Spread = Yield of non-Treasury Bond – Yield of Treasury Bond
Nominal Spread = 8% – 6.5% = 1.5%
The difference between the YTM for the two bonds is 1.5% (150 bps). This is the nominal spread.
A non-Treasury bond usually provides a higher yield compared to a Treasury bond because of the additional risk involved, especially the credit risk and the liquidity risk. It could also be because of other features such as the risk due to the embedded options.
Nominal spread is a way to price the bonds. Generally a spread is taken over the Treasury yield, and used as a discount factor to value the bond.
Even though it’s simple to calculate, it’s not a very strong measure because it doesn’t consider the spot rates for different maturities and it also ignores the effect of embedded options.
Due to this reason other spread measures such as the z-spread are more popular.