Normalizing Bond Yields for Coupon Differences
Summary
The document considers whether a high-coupon bond’s elevated price and Z-spread signal mispricing. It presents two ways to make comparisons across bonds with different coupons. Where principal and coupon strips are actively priced, a Treasury note’s price can be decomposed using the principal strip; the remaining value, scaled by its coupon, estimates the price per unit of coupon. That estimate can be used to calculate a comparable price and yield at another coupon level.
When strip prices are unavailable, the answer recommends plotting yields against duration rather than maturity, which can make bonds with differing coupon profiles easier to compare. It also cautions that Z-spread and option-adjusted spread calculations depend on the discount curve selected, so spread comparisons may be unclear when that curve is unspecified. The discussion offers normalization approaches, but it does not analyze the cited bond’s cash flows or establish whether it is mispriced.
Key ideas
- Coupon strip prices can help separate a bond’s principal value from its coupon value.
- Scaling the coupon component can estimate a comparable price at a different coupon rate.
- Plotting yield against duration can improve curve comparisons when strip markets are unavailable.
- Z-spread and option-adjusted spread comparisons depend on the discount curve used.
Tags
Full text
# Coupon Adjusted Spread vs Z-Spread # Coupon Adjusted Spread vs Z-Spread Hi so I'm trying to figure out how to adjust for the coupon value in the Z-Spread of a given bond. For example we can take UKRAIN 9.75 11/28. The coupon is 9.75 which is quite a bit higher than the rest of the curve (rest are around 7.5). The Z-Spread of this bond at the time of writing is 587, which is also quite a bit higher than the rest of the curve. The price, however is also much higher than the rest of the curve (115.5 approx). I suspect there is some mis-pricing going on here on account of the high coupon being heavily bid, but not to a correct amount. Any ideas of how I can go about this? ## Answer by Edward Watson (score 2, accepted) https://quant.stackexchange.com/a/63714 In the US we can adjust coupons on treasury notes and bonds of similar maturities using strip prices (principal and interest). If we have, for example, a 2% 2/15/2030 note and a 1% 11/15/2029 note and principal strip prices for each we can take the note price and subtract the principal strip price, divide by the coupon, to get the price per 1% of coupon. We can now adjust the 1% 11/15/2029 note to have a 2% coupon and a subsequent calculated yield. Without an active strip market, a helpful way to normalize curves with bonds of different coupons is to graph yields not versus maturity but duration. Your yield curve will make much more sense that way. There's nothing really wrong with a z-spread or oas for treasury relative value other than the fact that it might not be clear what discount curve their using to create the Z spread, or the oas which also needs a discount curve. Many people will discount using another curve like libor swaps.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.