Asset Swap Spread Versus Z-Spread

[cfa_gremlin]

Can someone tell me if my understanding of the difference between I-spread, Asset Swap Spread, and Z-Spread is correct?
I am going to be talking about the Asset Swap Spread and Z-spread based on the Zero-coupon SWAP spot curve.
I’ve read that the asset-swap spread is really the coupon of an annuity in the swap market that equals the difference between the market price of the bond and the value of the bond when cash flows are valued using zero-coupon swap rates.
Let’s use a 5-Year Bond with 6% coupon having semi-annual payments whose current price is 99.41 making it have a YTM of 6.23%.
Years Zero Swap Rates
0.5 4
1 4.1
1.5 4.2
2 4.3
2.5 4.35
3 4.4
3.5 4.45
4 4.5
4.5 4.55
5 4.6
To calculate I-spread you simply take the difference between YTM and 5yr Swap Rate and you arrive at 163bps
To calculate Z-spread you use iteration or GoalSeek in Excel and you arrive at 166bps
To calculate asset-swap spread I first calculate the value of the bond by discounting CFs by the zero swap rates and I arrive at 106.54.
The difference between this value and the market value of the bond is 7.13
I use iteration or GoalSeek in Excel to find the coupon, that when discounted by the zero swap rates, would sum to 7.13 and I arrive at 80.1771bps at which point I multiply the result by 2 to make it annual. I therefore arrive at 160.35.
From what I understand, this 160.35 figure would be the spread that would be added to Libor if the investor wanted to get into an asset swap to transform his 6% fixed rate bond into a floating rate bond.
Thanks in advance.

 

[MFE]

the main difference between Z-spread and asset swap spread is Z-spread assumes constant credit spread through out the bond, while the asset swap is more “the market”. I recently read some research by credit derivative IB that shows many more IG names are now inverted credit spread curves, based off CDS markets. For instance CFC may be trading at 1100bps for 2 year CDS, 900bps 5 yr , 850 bps 7 yr and 600bps 10yr. To “arb” this you would need to use the asset spread model on the cash bond, but then again, things can get worse before they get better, and you are really left with mark to market risk & counterparty risk, but I see certain bonds are paying 100bps+ for this… sounds like a good trade to me.

 

[cfa_gremlin]

“the main difference between Z-spread and asset swap spread is Z-spread assumes constant credit spread through out the bond, while the asset swap is more “the market””
I don’t quite follow….so you’re saying a quoted asset swap spread is an average spread across an entity’s credit term structure? If that’s what you’re saying I respectfully disagree.
If you wanted to “arb” the positive slope and negative slope between cash and CDS, traders would use the z-spread not the asset swap spread, but as you note the discrepancy can get bigger or persist even though the entry is attractive currently.

 

[MFE]

“I don’t quite follow….so you’re saying a quoted asset swap spread is an average spread across an entity’s credit term structure? If that’s what you’re saying I respectfully disagree. ”
nope that is not what i said, not even close. more like the opposite.