What is the zero volatility spread?

The Zero-volatility spread, also known as the Z-spread, is a fundamental concept in finance that enables the valuation of securities. This spread serves as a constant adjustment factor.

By adding the Z-spread to the yield at each point on the spot rate Treasury curve where cash flow is received, it ensures that the resulting present value of the cash flows equals the price of the security.

The significance of the Z-spread lies in its ability to account for the credit risk associated with a security. It adjusts the yield curve to reflect the market's perception of the riskiness of the security.

Consequently, the Z-spread provides investors with a more accurate assessment of the security's value, taking into consideration both the timing and the risk of the cash flows.

Moreover, the Z-spread can be used to compare securities with different maturities and credit qualities, as it adjusts for the differences in the underlying yield curves.