Yield spread

Written by Fmi.Online Thursday November 10, 2022
The yield spread, also known as the credit spread, is the difference between the yields of two investments in terms of credit quality and the risk of investing in one debt instrument instead of another instrument.

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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