Comparing Fixed-Bond and Floating-Rate Spreads

Summary

The document explains how to compare spreads on fixed-coupon bonds and loans or floating-rate notes. Its answer says that the fixed bond’s additional interest-rate exposure need not justify a separate spread adjustment, since that exposure can be hedged at negligible cost. Properly calculated Z-spreads and option-adjusted spreads can therefore be compared across fixed and floating instruments without subtracting another swap-rate component.

For a fixed bond, the Z-spread is already approximately related to its yield less the swap rate at maturity. For amortizing bonds or those with substantial coupons, a weighted average of swap rates may be more appropriate. The discussion is concise and conceptual: it gives no worked example and does not detail differences in credit, liquidity, optionality, or conventions that may affect comparisons in practice.

Key ideas

• A fixed coupon’s interest-rate exposure can be hedged, so it does not automatically warrant an extra spread discount.
• Correctly calculated Z-spreads or option-adjusted spreads can be compared across fixed and floating instruments.
• A fixed bond’s Z-spread already reflects a benchmark-rate comparison, so subtracting the swap rate again is redundant.
• Amortization or large coupons may make a weighted average of swap rates a better reference than the terminal maturity rate.

Tags

# Compare Spread On A Fixed Bond Vs A Loan/FRN?


# Compare Spread On A Fixed Bond Vs A Loan/FRN?












I was discussing with a colleague, but in short, how do you compare a fixed bond vs a loan/frn when it comes to spread? Theoretically, you should get paid more for holding fixed bonds, as you have duration risk, so in my view you need to take the z spread of said fixed bond, substract the equivalent maturity swap rate, and compare the result vs the DM/zDM of the loan/FRN. Is this right?

## Answer by Dimitri Vulis (score 1)

https://quant.stackexchange.com/a/77582

No. You can hedge the interest rate risk of a fixed-coupon instrument at immaterial cost. Don't discount a fixed-coupon instrument more than a floater because of the presense of additional interest rate risk.

Spread calculations such as Z-spread and OAS, if done correctly, are comparable for fixed-coupon and floating instruments without the need for further adjustments.

A Z-spread of a fixed-coupon bond is already approximately equal to its yield minus the swap rate at the bond's maturity (or, even better, minus a weighted average of swap rates if the bond amortizes or pays large coupon). Subtracting the swap rate once again won't give rise to an economically meaningful figure.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.