The Zero-Volatility Spread (Z-spread) is a constant basis point spread that, when added to every point on the risk-free spot rate curve, makes the present value of a bond's cash flows equal to its current market price. Unlike a simple yield spread that compares a bond's yield to a single benchmark rate, the Z-spread accounts for the full shape of the yield curve by discounting each cash flow at the corresponding risk-free spot rate plus the constant spread. The Z-spread measures the total compensation an investor demands over the risk-free rate for holding a bond — capturing credit risk, liquidity risk, and optionality risk. For Indian corporate bond investors, the Z-spread over the government securities curve is a cleaner measure of credit risk premium than a simple yield spread, particularly for bonds with irregular cash flows or complex structures.
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