finance Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...

, the yield spread or credit spread is the difference between the quoted rates of return on two different

investments Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

, usually of different credit qualities but similar maturities. It is often an indication of the

risk premium A risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics, the general definition being the expected risky Rate of retur ...

for one investment product over another. The phrase is a compound of yield and spread. The "yield spread of X over Y" is generally the annualized percentage

yield to maturity The yield to maturity (YTM), book yield or redemption yield of a fixed-interest security is an estimate of the total rate of return anticipated to be earned by an investor who buys it at a given market price, holds it to maturity, and receives ...

(YTM) of

financial instrument Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership, interest in an entity or a contractual right to receive or deliver in the form ...

X minus the YTM of financial instrument Y. There are several measures of yield spread relative to a benchmark

yield curve In finance, the yield curve is a graph which depicts how the Yield to maturity, yields on debt instruments – such as bonds – vary as a function of their years remaining to Maturity (finance), maturity. Typically, the graph's horizontal ...

, including interpolated spread ( I-spread), zero-volatility spread ( Z-spread), and option-adjusted spread (OAS). It is also possible to define a yield spread between two different maturities of otherwise comparable bonds. For example, if a certain bond with a 10-year maturity yields 8% and a comparable bond from the same issuer with a 5-year maturity yields 5%, then the term premium between them may be quoted as 8% – 5% = 3%. A "credit spread curve" (usually, positively sloped) depicts the relationship between credit spread and maturity, i.e. term structure; curves may also be constructed for credit structure.

Yield spread analysis

Yield spread analysis involves comparing the yield, maturity, liquidity and creditworthiness of two instruments, or of one security relative to a benchmark, and tracking how particular patterns vary over time. When yield spreads widen between bond categories with different credit ratings, all else equal, it implies that the market is factoring more risk of default on the lower-grade bonds. For example, if a risk-free 10-year Treasury note is currently yielding 5% while junk bonds with the same duration are averaging 7%, then the spread between Treasuries and junk bonds is 2%. If that spread widens to 4% (increasing the junk bond yield to 9%), then the market is forecasting a greater risk of default, probably because of weaker economic prospects for the borrowers. A narrowing of yield spreads (between bonds of different risk ratings) implies that the market is factoring in less risk, probably due to an improving economic outlook. The TED spread is one commonly-quoted credit spread. The difference between Baa-rated ten-year corporate bonds and ten-year Treasuries is another commonly-quoted credit spread.Macro Musings Blog. 26 November 2008
What Corporate Bond Yield Spreads Tell Us
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Consumer loans

Yield spread can also be an indicator of profitability for a lender providing a loan to an individual borrower. For consumer loans, particularly home

mortgages A mortgage loan or simply mortgage (), in civil law jurisdictions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any pur ...

, an important yield spread is the difference between the interest rate actually paid by the borrower on a particular loan and the (lower) interest rate that the borrower's credit would allow that borrower to pay. For example, if a borrower's credit is good enough to qualify for a loan at 5% interest rate but accepts a loan at 6%, then the extra 1% yield spread (with the same credit risk) translates into additional profit for the lender. As a business strategy, lenders typically offer

yield spread premium A yield spread premium (YSP) is the money or rebate paid to a mortgage broker for giving a borrower a higher interest rate on a loan in exchange for lower up front costs, generally paid in origination fees, broker fees or discount points. This � ...

s to brokers who identify borrowers willing to pay higher yield spreads.

Notes

{{Bond market Bond valuation Fixed income analysis Credit risk

Yield spread analysis

Consumer loans

See also

Notes