I’m new here just wanted to say hello to all the helpful people on this forum. I’ve actually been watching this forum from my CFA 1 days but got compelled to join as I’m doing the Level 2 exam in a couple of days.
I’ve got a couple of niggling areas so I’ll start with the first one on this post:
Does anyone have a simple way or a summary to descrive the swap curves? Specifically: z spread, OAS spread, swap spread, i-spread, TED spread, LIBOR-OIS spread?
I know there’s a ton of material out there but the general explanations are just not making sense to me. What I’d like to understand is how they relate to credit, liquidity and option risk? For example, I’m aware Z spread accounts for credit + liquidity + option risk, but what does that actually mean?
The z spread is a spread needed to be added to the spot curve to make the bonds cash flows equal its current market price. You would basically take a known, the spot curve rates, and another known, the price of the bond, and solve for what spread needs to be added to make the value of the cash flows equal the price of the bond. The rates for the spot curve are for a risk free bond, so you are adjusting for risk etc.
LIBOR-OIS is comparing the LIBOR rate (which is an unsecured overnight loan) to the Overnight indexed swap which is based on the Fed Funds rate. Because the OIS rate is a swap rate there is minimal credit risk as you just swap payments. It is an aoverall gauge of the markets. When there is a higher spread, banks may be uneasy at lending to on another