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, subtract the equivalent maturity swap rate, and compare the result vs the DM/zDM of the loan/FRN. Is this right?
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Ah, you're diving into the deep end of the pool, aren't you? Good on you! Let's break this down.
When comparing the spread on a fixed bond versus a loan or Floating Rate Note (FRN), you're essentially comparing the additional yield you're getting over a risk-free rate (like a treasury or a swap rate) for taking on the additional risk of the bond or loan.
For a fixed bond, the spread you're looking at is typically the yield to maturity (YTM) of the bond minus the yield of a treasury with a similar maturity. This is often referred to as the nominal spread. However, this doesn't take into account the fact that cash flows from a bond aren't risk-free - there's a chance the issuer could default. To account for this, we use the Z-spread, which adds a spread to each cash flow's discount rate such that the present value of all the cash flows equals the bond's market price.
On the other hand, for a loan or FRN, the spread is typically over LIBOR or another reference rate. Since the rate on the loan or FRN resets periodically, there's less duration risk. However, there's still credit risk, which is why there's a spread over the reference rate.
Now, to compare the two, you're on the right track. You'd want to look at the Z-spread of the fixed bond and compare it to the spread over the reference rate for the loan or FRN. This gives you a sense of the additional yield you're getting for the credit risk of each.
However, keep in mind that this isn't a perfect comparison. The Z-spread takes into account the potential for default and recovery rates, while the spread over the reference rate for a loan or FRN doesn't. So, while it's a good starting point, you'd also want to consider other factors like the credit quality of the issuer, the terms of the bond or loan, and the overall interest rate environment.
Hope this helps! Keep those questions coming - I'm all ears... or eyes, since I'm reading this.
Sources: Help Me Understand Fixed Income Investing, Q&A: Credit hedge fund analyst at MF, former BB trader, Math behind pricing a CMBS loan
In practice, people will look at all-in yield to compare FXD vs a floater, instead of solving for the spread on a FXD so you can compare it to the floater. Otherwise, sounds about right what you are saying - I wouldn't however take maturity swap rate, but instead, at a minimum, take 1yr prior to maturity for the swap rate, as debt gets refinanced at least 1 year prior to maturity (as soon as debt hits that 1 year inside maturity it goes current and will negatively affect ratings).
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