What is Spread?
The spread is the bond market's risk premium — the extra yield investors demand for taking on additional risk. A corporate bond yielding 1.5% more than Bunds has a 150 basis point spread, compensating for its credit risk.
A spread is the yield difference between two bonds, typically expressed in basis points (1 bp = 0.01%). Spreads measure relative value and credit risk. The most common is the credit spread: the extra yield a bond pays over a risk-free benchmark like German Bunds.
Types of Spreads
Credit spread: Corporate vs. government bond yield. Sovereign spread: One country's bonds vs. another (e.g., Italy vs. Germany). Swap spread: Bond yield vs. interest rate swap. Option-adjusted spread (OAS): Spread adjusted for embedded options like call provisions.
What Drives Spreads
Credit quality: Lower ratings = wider spreads. Market conditions: Spreads widen in crises ('flight to quality'), narrow in calm markets. Liquidity: Less-traded bonds have wider spreads. Duration: Longer bonds typically have wider spreads. Supply/demand: New issuance can temporarily widen spreads.
Reading Basis Points
Spreads are quoted in basis points (bps). 100 bps = 1.00%. A bond at 'Bunds + 75' yields 0.75% more than equivalent-maturity Bunds. If Bunds yield 2.50%, this bond yields 3.25%. Spreads can tighten (narrow) or widen.
Typical Spreads by Credit Quality
| Rating | Typical Spread to Bunds | Example Issuer |
|---|---|---|
| AAA | 10-30 bps | KfW, EIB |
| AA | 30-60 bps | Large German corporates |
| A | 60-120 bps | Solid investment grade |
| BBB | 120-200 bps | Lower investment grade |
| BB (Junk) | 200-400 bps | Speculative grade |
| B or lower | 400+ bps | High yield/distressed |
Practical Example: Analyzing Spreads
Company X's 5-year bond yields 4.25%. The 5-year Bund yields 2.50%. Spread: 175 bps. Six months later, bad earnings widen the spread to 250 bps. Even if Bund yields are unchanged, Company X's bond now yields 5.00%, and its price has fallen. Spread movements often matter more than absolute yield changes.
Frequently Asked Questions
What is a spread in simple terms?
A spread is the extra yield one bond pays compared to another. If a corporate bond yields 1% more than a government bond, that's the spread — your compensation for the extra risk.
What does 'spreads are widening' mean?
Spreads widen when riskier bonds underperform safe bonds — their yields rise relative to benchmarks. This happens when investors worry about credit risk or the economy. Wider spreads = higher perceived risk.
Why are spreads important?
Spreads tell you if you're being adequately compensated for risk. A tight spread on a weak credit may mean poor value. Wide spreads on strong credits may signal opportunity.
What is a basis point?
One basis point (bp) = 0.01%. So 50 bps = 0.50%. Traders use basis points because saying '50 bps' is clearer than '0.5 percentage points' or 'half a percent.'
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