# Z-Spread: Definition and Calculation

The problem with **nominal spread** is that it measures the spread at just one point on the yield curve. The z-spread solves this problem by considering the spot yield curve instead of the standard yield curve.

The z-spread, also known as the zero-volatility spread or the static spread, measures the spread that the investor will receive over the entire **Treasury spot rate curve**.

For the purpose of calculation, we start with an assumption for the z-spread. One takes the Treasury spot rates for each maturity, adds the z-spread to it, and uses this new rate as a discount rate for each maturity to price the bond. The correct z-spread is the one that makes the present value of cash flows equal to the price of the bond.

*P = C _{1}/(1+r_{1}*

*+ z) + C*

_{2}/(1+r_{2}

*+ z)*

^{2}

*+ C*

_{3}/(1+r_{3}

*+ z)*

^{3}

*... T(1+r*

_{n}

*+ z)*

^{n}Where,

- P represents the clean price of the bond plus any accrued interest.
- C represents the coupon payments.
- T represents the total cash flow received at maturity
- r1,r2… represent the zero spot rates for each maturity
- z represents the z-spread.

Note that the benchmark for calculating z-spread is the spot rate curve. Unlike nominal spread, the z-spread is spread over the entire Treasury spot rate curve.

The z-spread represents the additional risk the investor is taking in the form of credit risk, liquidity risk, and option risk.

In most cases, such as for the vanilla coupon paying bonds, the z-spread will only slightly diverge from the nominal spread. The difference mainly comes from the shape of the term structure and the bond characteristics. For example, the difference will be high for amortizing bonds for which the principal is repaid over time, bonds with high coupon, and when the yield curve is steep.

- Sources of Return from Investing in a Bond
- How to Calculate Current Yield
- How to Calculate Yield to Maturity
- Bond Equivalent Yield Convention
- Yield to Maturity (YTM) Approximation Formula
- YTM and Reinvestment Risk
- Factors Affecting Reinvestment Risk
- Calculate Bond-Equivalent Yield of Annual-Pay Bonds
- How to Calculate Yield to Call of a Bond
- Cash Flow Yield
- Bootstrapping Spot Rate Curve (Zero Curve)
- How to Price a Bond Using Spot Rates (Zero Curve)
- Nominal Spread
- Z-Spread: Definition and Calculation
- Option-adjusted Spreads (OAS)
- What are Forward Rates?
- How to Calculate Forward Rates from Spot Rates?
- How to Value a Bond Using Forward Rates

# R Programming Bundle: 25% OFF

**R Programming - Data Science for Finance Bundle**for just $29 $39.