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KIC000100 - Static& Option Adjusted Spread FIN 327 ‘...

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Unformatted text preview: Static & Option Adjusted Spread FIN 327 ‘ Prof. Hood Problems with YTM Spread - YTM is dependent on timing of cash flows. - Comparing a defaultable security to a risk—free security with different cash flows impacts YTM . What else are we assuming with YTM? - Since we know the promised cash flows for a defaultable bond, we can use information about the term structure of risk-free rates to discount them. Static or Z Spread . Using the cash flow fora defaultable bond, we can add to the spot rate to get the price that matches the market. Adding a constant is comparable ta the YTM spread. The constant number added to the spot rate that makes the discounted cash flows equal to the market price is the static spread. This is also known as the Z spread since there is zero volatility in interest rates, but we are taking the term structure expectations in to account. How can we solve forthe Z spread? <W‘ hwmamnn- - ...
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