Explanation:
The Z-spread, also known as the zero-volatility spread, is a measure of the spread that a bond will yield over the entire Treasury spot rate curve. It is used in the valuation of bonds, particularly those with embedded options. When the options in a bond expire before the bond's maturity, the option-adjusted spread (OAS) becomes equivalent to the Z-spread. This is because the OAS is a measure of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. In the absence of the option, the OAS defaults to the Z-spread. Therefore, in the given scenario where all options have expired, the Z-spread becomes the most suitable alternative for the fund manager to use for valuation purposes.
Choice A is incorrect. The credit default swap spread is not the most suitable alternative in this context.
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Q.1812 Assume that a fund manager runs a special portfolio composed of option-embedded bonds and, in their valuation, uses option-adjusted spreads. At some point in time – due to a shocking event – all options expire but the bonds still have some time to maturity. For the fund manager, which of the following spread representations will be the next best alternative for valuation purposes?
A
Credit default swap spread
B
Asset-swap spread
C
Yield spread
D
Z-spread