CFAI Vol 4, R21, page 90, question 13C

CFA Level III Fixed Income
#1

The question reads

13C Compare the advantages/disadvantage of the nominal spread framework to the swap spread framework.

CFAI answer on page 98 is

Individual investors understand the traditional nominal spread framework as a market convention. Moreover despite its limitations, this framework can be used across the entire credit-quality spectrum from Aaa’s to B’s. The disadvantage is that the nominal spread framework does not work very well for investors and issuers in comparing the relative attractiveness between the fixed- and floating-rate markets. This is the advantage of using the swap framework.

I don’t understand why the nominal spread does not work well when comparing fixed vs. floating issues while the swap spread apparently does the job. Anyone gets this?

#2

The nominal spread is the difference in YTM between a given bond (say, a corporate bond) and a government bond of the same maturity (e.g., a US Treasury). It generally compares a fixed rate bond (the corporate) to a fixed-rate bond (the Treasury); there is no floating rate (e.g., LIBOR) involved.

The swap spread compares the fixed rate on a (plain vanilla, fixed-for-floating) swap with the Treasury bond of the same maturity. It explicitly includes a floating rate comparison: the floating rate in the swap (usually LIBOR).

A framework that explicitly includes both a fixed rate and a floating rate will be better at somparing fixed-rate and floating-rate bonds than a framework that involves only fixed rates.

#3

Many thanks S2000magician

#4

My pleasure.