hard · Debt Capital Markets pricing-yields-curve
A 5-year bullet bond with a 7% annual coupon trades at a G-spread of 90 bp over a steeply upward-sloping swap curve (5-year par swap rate 3.2%). A junior trader insists the Z-spread must lie between the G-spread and the par/par asset-swap spread of 78 bp.
What is the most precise reason the Z-spread will instead EXCEED the 90 bp G-spread here?
- Because the par/par asset-swap structure funds the off-market coupon, the ASW spread is mechanically depressed below both G and Z, while G and Z are nearly identical for any bond.
- Because a high coupon shortens effective duration, the Z-spread is applied over a shorter horizon and must therefore be scaled up above the G-spread to match the dirty price.
- Because the above-market coupon front-loads cash flows onto the low-rate front of a steep curve, a single flat add-on to every zero rate must rise above the single-point G-spread to reproduce the price.
- Because the curve is upward-sloping, the Z-spread always exceeds the G-spread by exactly the par/par funding adjustment embedded in the ASW spread, here 12 bp.
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