Z-spread

What is it?

The Z-spread, or zero-volatility spread, is the constant amount that must be added to every point of the government zero-coupon curve so that the bond's discounted cash flows equal its market price. Unlike a simple yield difference, it accounts for the entire shape of the benchmark curve rather than a single point on it.

The following equation is solved for the spread:

Bond Price = ∑ ( CashFlow ÷ (1 + ZeroRate + ZSpread) ^ Time )

Z-Spread (basis points) = ZSpread × 10000

• BondPrice – current market price of the bond, including accrued interest.
• CashFlow – coupon payment, or coupon plus redemption amount for the final one, up to the redemption date that produced the yield to worst.
• Time – time from today until the cash flow, in years.
• ZeroRate – government zero-coupon rate for that same term, expressed as an annual effective rate, derived from published benchmark yields.
• ZSpread – the constant premium being solved for, expressed as a decimal.

The Z-spread is a standard measure of the spread required over a benchmark zero curve to reproduce the bond's market price because it remains comparable across bonds with different maturities, coupon sizes and payment schedules.