I was discussing with a colleague, but in short, how do you compare a fixed bond vs a loan/frn when it comes to spread? Theoretically, you should get paid more for holding fixed bonds, as you have duration risk, so in my view you need to take the z spread of said fixed bond, substract the equivalent maturity swap rate, and compare the result vs the DM/zDM of the loan/FRN. Is this right?
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No. You can hedge the interest rate risk of a fixed-coupon instrument at immaterial cost. Don't discount a fixed-coupon instrument more than a floater because of the presense of additional interest rate risk.
Spread calculations such as Z-spread and OAS, if done correctly, are comparable for fixed-coupon and floating instruments without the need for further adjustments.
A Z-spread of a fixed-coupon bond is already approximately equal to its yield minus the swap rate at the bond's maturity (or, even better, minus a weighted average of swap rates if the bond amortizes or pays large coupon). Subtracting the swap rate once again won't give rise to an economically meaningful figure.
answered Dec 2, 2023 at 14:54
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$\begingroup$ Thank you for that. So would it make more sense to compare a zDM to an ASW? $\endgroup$– YuppityCommented Dec 2, 2023 at 15:31
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$\begingroup$ For rich-cheap comparisons of credit instruments, backing out and comparing their implied CDS spreads, like VCDS on Bloomberg, is sometimes most insightful. I should also add that although certain textbooks postulate that floaters never have interest rate risk, one can exercise critical thinking and actually calculate the interest rate risk of a high-yield loan: index+fixed spread, like 600 or 700 bps. It's big enough to warrant hedging if not wanted. Perhaps this is why in some markets, like Brazil, they prefere gearing index*g instead of index+s, for credit-risky floaters. $\endgroup$ Commented Dec 2, 2023 at 18:19