Dear folks:
Can any folk explain why Z-DM will be lower than the DM When Z-DM is using higher MRR spot rates?
-quote-
The calculation of the Z-DM will use higher MRR spot rates for longer maturities when discounting cash flows, which will cause the Z-DM to be lower than the DM (which assumes the MRR remains unchanged in its calculation.
-unquote-
Many Thanks for your kind reply
The logic is mathematical.
Iin both cases we are solving DM or Z-DM given a known bond
The DM method assumes the yield curve is flat. It adds the same premium to the same ytm to do the disocunting and adds the same quoted margin to the MRR. Once you have initially worked out the QM and discount rate, you are using the same for all payments treating a bit like a fixed rate bond with the same discount rate
The Z-DM adds the same QM to the spot rates. The Z-DM is also added to spot rates, so different for exach coupon period.
Itis the case the if the yield curve is upward sloping the solved for Z-DM will be less than the DM.
Here is an example
What I don’t get is why twe don’t use forward rates for calcualing coupon payments rate than spot. I see why you use spot for discounting and calcualting z-DM but I think Qm should be a premium to fwd rates, as when those are the rates and there couppns the market is anticpating.
Still lower than the DM method but much closer
