Relative Value Analysis of Fixed‐Income Products

Abstract

Valuation of fixed-income products employs one of two basic methods—discounted cash flows and relative value. Methods using discounted cash flows require several assumptions to be used as inputs but produce a precise valuation result. The tools of relative value analysis are less ambitious. They help us discern differences in value between two similar bonds on a relative basis. Relative value analysis investors make statements such as “Bond X is cheaper than Bond Y.” Relative value tools range in complexity from yield spreads to asset swap spreads and the credit default swap basis. Keywords: discounted cash flow method; relative valuation; swap rate; swap curve; LIBOR curve; cheapest to deliver; interpolated spread; asset swap spread; par structure; credit default swaps; credit event; credit default swap basis