Asset Swap: selection of cheapness bond

[profeta]

Hi everybody,

someone could tell me why the spread of an asset swap is used to determine the cheapness of the underlying bond?

Thanks

 

[A Dashing Blade]

It's not.
It's used to determine the relative cheapness of a bond against other bonds of the same currency.
A googling of "Asset Swap Spread" and a couple of hours of your time may prove useful.

 

[profeta]

ok, .
and I suppose I have to compare bond with the same currency but also with the same maturity
But what I don't uderstand it is why I have to use asset swap,
to compare bonds why I can't simply use the yield to maturity?
Asset swap gives me more information than yield to maturity?

For example:

1) Italy bond govt BTP 4 1/4 2018
price 97.18 / 97.31
Asset swap +5.9
Yield to Maturity 4.896

2) France bond govt OAT 4 2018
price 95.47 / 95.51
Asset swap -23.7
Yield to Maturity 4.57

I suppose Asset swap spread tells me that BTP is cheaper
but also Yield to maturity seems to give me the same information

 

[A Dashing Blade]

YTM is pretty meaningless as it assumes being able to re-invest all future cash flows at current rates.

Asset swap uses the swap curve to discount all future cv's with the assumption that an initial cash flow of 100-current price is also made (think of it as converting the bond into a par swap).

The current cheapness of the BTPs you mention is due to liquidity and perceived credit-worthiness of Italian paper atm.

Btw, don't think there is a BTP 4.25 of 2018, suspect you meant the 4.5's of Feb or Aug

 

[profeta]

Yes sorry, the Btp meant has a 4 1/2 coupon maturity feb 2018

I agree with you why the Btp is cheaper than OAT (liquidity and credit) and how to calculate the asset swap price (or spread)

So do you tell me that only for that pretty meaningless people usually speak in term of spread of asset swap instead of YTM?

If that is the main reason I feel good because I usually analyse the bond govt in term of YTM and since today I have done an academical wrong and not a substantial or essential wrong

 

[profeta]

obviosuly to be acamical compliant I am starting to speak in term of Asset swap spread


thanks

 

[SnortSterling]

you should use swap spreads

Comparing yields doesn't take into account the shape of the yield curve. So for example if you take two bonds that are both fair to the curve, and the curve is very steep then a 3 year bond will have a higher yield than a 2.75 year bond even though it's not really cheaper. (You are just being paid to extend duration).

(Asset swap spreads are better than just making comparisons of raw yields, but really you should use the OAS (option-adjusted spread) pioneered by the old Salmon Brothers. Basically figure out how much you need to bump the LIBOR curve to discount the cash flows of the bond to equal its current price. If you don't understand this bit, don't worry.)

Using the swap curve to assess relative value of bonds works well - provided the swap curve is fair. It tends to be reasonably fair in EUR, but can be distorted sometimes in USD and most of the time in GBP.

 

[A Dashing Blade]

. . . (Asset swap spreads are better than just making comparisons of raw yields, but really you should use the OAS (option-adjusted spread) pioneered by the old Salmon Brothers. Basically figure out how much you need to bump the LIBOR curve to discount the cash flows of the bond to equal its current price. If you don't understand this bit, don't worry.)
. . .

But if a bond has no embedded options, isn't this is the same as the Z-spread?

 

[profeta]

Comparing yields doesn't take into account the shape of the yield curve. So for example if you take two bonds that are both fair to the curve, and the curve is very steep then a 3 year bond will have a higher yield than a 2.75 year bond even though it's not really cheaper. (You are just being paid to extend duration).

(Asset swap spreads are better than just making comparisons of raw yields, but really you should use the OAS (option-adjusted spread) pioneered by the old Salmon Brothers. Basically figure out how much you need to bump the LIBOR curve to discount the cash flows of the bond to equal its current price. If you don't understand this bit, don't worry.)

Using the swap curve to assess relative value of bonds works well - provided the swap curve is fair. It tends to be reasonably fair in EUR, but can be distorted sometimes in USD and most of the time in GBP.

Using OAS, YTM, Asset swap spread, in a practical way seem to give the same information regarding to the cheapness of a bond

Comparing two bond of the same maturity but different issuer:
1) Fiat (rating BB )
2) Allianz Insurance (rating AA-)

For liquidity and credit risk I suppose the Fiat corporate bond is cheaper and:
a) OAS of Fiat > OAS of Allianz
b) Asset swap spread of Fiat > Asset swap spread of Allianz
c) YTM of Fiat > YTM of Allianz