I-Spread: Calculating and Analyzing Corporate Bond Spreads

I-Spread is a crucial metric for investors to understand the relative value of corporate bonds. It measures the difference between a bond's yield and the yield of a comparable government bond.

The I-Spread is calculated by subtracting the yield of the government bond from the yield of the corporate bond. This calculation provides a clear picture of the additional yield an investor can expect from a corporate bond compared to a government bond.

A lower I-Spread indicates that the corporate bond offers a relatively lower yield compared to the government bond, while a higher I-Spread suggests a higher yield for the corporate bond. This makes I-Spread an essential tool for investors to assess the attractiveness of a corporate bond.

By analyzing I-Spread, investors can make informed decisions about which corporate bonds to invest in and when to buy or sell them.

The I-Spread is a crucial concept in finance, and understanding its basics is essential for making informed decisions.

The I-Spread is defined as the yield spread of a bond over the standard swap rate in the same currency and with the same tenor. This is commonly used for euro-denominated corporate bonds.

Short-term funding is key for corporations to meet immediate cash needs, maintain liquidity, and ensure smooth operations.

Calculating the I-spread is straightforward once you understand the concept. It's the yield spread of a specific bond over the standard swap rate in that currency of the same tenor.

To calculate the I-spread, you simply subtract the swap rate from the yield-to-maturity of the bond. For example, in Example 3, the I-spread is 3.5% - 2.2% = 1.30% = 130bps.

In a real-world scenario, as shown in Example 4, the I-spread can be calculated by solving for the yield-to-maturity of the corporate bond and the government benchmark bond, and then finding the difference between the two.

Calculating spreads is a crucial step in evaluating the value of a bond. Understanding the different types of spreads is essential for investors and analysts alike.

The yield spread is the difference in yield between a fixed-income security and a benchmark. This spread reflects microeconomic factors, such as the credit quality of the issuer and the bond.

A G-spread is the yield spread in basis points over an interpolated government bond. The spread is higher for bonds with higher credit, liquidity, and other risks relative to the government bond. For example, a 3-year corporate bond with a yield-to-maturity of 7.00% and a benchmark rate of 3-year Libor at 5.00% has a G-spread of 2.00%.

The I-spread is the yield spread of a specific bond over the standard swap rate in that currency and with the same tenor. The yield-to-maturity for the corporate bond is 3.5%, and the swap rate for the same maturity is 2.2%. This results in an I-spread of 130 bps.

The Z-spread, also known as the static spread, is based on the entire benchmark spot curve. It is the constant spread that is added to each spot rate such that the present value of the cash flows matches the price of the bond. The Z-spread is calculated using the spot rates and the price of the bond.

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Here's a summary of the different spreads:

To calculate the Z-spread, we must solve for Z in the equation, given the spot rates and price of the bond. The Solver add-in for Microsoft Excel finds Z = 1.22, or 122bp, by setting the price (sum of present values of cash flows) equal to 97.50 as the objective and Z as the change variable.

The OAS (Option-Adjusted Spread) is the Z-spread adjusted for the value of any embedded options like call or put options. It is based on an option-pricing model and an assumption about future interest rate volatility.

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Calculating the Yield to Maturity (YTM) is a crucial step in understanding the total anticipated return on a bond. This measure takes into account both the current market price and the total amount of interest payments.

The YTM is the interest rate that equates the present value of the bond's future cash flows to its current market price. It can be found by solving an equation that considers the periodic coupon payments and the face value of the bond.

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To solve for YTM, you'll need to use the bond pricing equation, which is a formula that calculates the present value of a bond's future cash flows. This equation is:

PV = PMT_1 / (1+r)^1 + PMT_2 / (1+r)^2 + ... + (PMT_N + FV_N) / (1+r)^N

Where:

For example, if a bond has a coupon rate of 6% and pays coupons semi-annually, the semi-annual coupon payment is $30. This means that the bond pays a total of 10 coupons and a face value of $1,000, making N = 10.

A bond with a coupon rate of 6% and a semi-annual coupon payment of $30 can be used to calculate the YTM. The YTM for this bond is approximately 6.475%, representing the total anticipated return if the bond is held to maturity.

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Calculating the current yield is a crucial step in understanding a bond's performance. The current yield is a measure that represents the annual income as a proportion of the bond's current market price.

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It's calculated using the formula: Current Yield = Annual Income / Current Market Price. This formula is essential in determining the bond's attractiveness to investors.

The annual income is calculated as a percentage of the bond's face value, for example, 6% of $1,000 is $60. This income is what investors receive periodically, usually semi-annually or annually.

The current market price of a bond can fluctuate, affecting the current yield. For instance, a bond with a face value of $1,000 and a market price of $980 would have a current yield of approximately 6.12%.

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Spreads are a crucial concept in fixed-income securities, and understanding them can help you make informed investment decisions. The yield spread is the difference in yield between a fixed-income security and a benchmark, such as a government bond or a swap rate.

The G-spread is the yield spread in basis points over an interpolated government bond. It's higher for bonds with higher credit, liquidity, and other risks relative to the government bond. For example, a 3-year corporate bond with a yield-to-maturity of 7.00% and a 3-year government bond with a yield-to-maturity of 5.00% would have a G-spread of 2.00%.

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The I-spread, on the other hand, is the yield spread of a specific bond over the standard swap rate in that currency and with the same tenor. In Example 1, the I-spread for the XYZ Corp bond is 1.30% or 130bps, calculated as the difference between the bond's yield-to-maturity (3.5%) and the swap rate for the same maturity (2.2%).

The Z-spread is the constant spread that is added to each spot rate such that the present value of the cash flows matches the price of the bond. It's also called the static spread as it's constant for all periods. To calculate the Z-spread, you must solve for Z in the equation given the spot rates and price of the bond.

Here's a summary of the different spreads:

Understanding these spreads can help you evaluate the relative value of a bond and make informed investment decisions.