Explanation :
The yield spread is measured in basis points (bps) and enables bond investors to compare the yield, maturity, liquidity and solvency of two debt instruments. For instance, the yield of a municipal bond is 7.50%, and the yield of a corporate bond is 8.50%. The difference between the two yields is: 8.50% – 7.50% = 1% or 100 basis points (one basis point = 0.01%). However, a corporate bond is riskier and has a shorter maturity than a municipal bond. All these factors are taken into consideration when comparing one security over another using the yield spread.In a nutshell :
- A yield spread is a difference between the quoted rate of return on different debt instruments which often have varying maturities, credit ratings, and risk.
- The spread is straightforward to calculate since you subtract the yield of one from that of the other in terms of percentage or basis points.
- Yield spreads are often quoted in terms of a yield versus U.S. Treasuries, or a yield versus AAA-rated corporate bonds.
- When yield spreads expand or contract, it can signal changes in the underlying economy or financial markets.
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