yield spread

A yield spread ⇒ is the difference between the yields of two different bonds. Yield spreads are typically quoted in basis points.

A yield spread relative to a benchmark bond is known as a benchmark spread. For example, if a 5-year corporate bond has a yield of 6.25% and its benchmark, the 5-year Treasury note, has a yield of 3.50%, the corporate bond has a benchmark spread of 625 − 350 = 275 basis points.

For fixed-coupon bonds, on-the-run government bond yields for the same or nearest maturity are frequently used as benchmarks. The benchmark may change during a bond’s life. For a 5- year corporate bond, when issued, the benchmark spread is stated relative to a 5-year government bond yield, but two years later (when it has three years remaining to maturity) its benchmark spread will be stated relative to a 3-year government bond yield. A yield spread over a government bond is also known as a G-spread.

An alternative to using government bond yields as benchmarks is to use rates for interest rate swaps in the same currency and with the same tenor as a bond. Yield spreads relative to swap rates are known as interpolated spreads or I-spreads. I-spreads are frequently stated for bonds denominated in euros.

Yield spreads are useful for analyzing the factors that affect a bond’s yield. If a corporate bond’s yield increases from 6.25% to 6.50%, this may have been caused by factors that affect all bond yields (macroeconomic factors) or by firm-specific or industry-specific (microeconomic) factors. If a bond’s yield increases but its yield spread remains the same, the yield on itsbenchmark must have also increased, which suggests macroeconomic factors caused bond yields in general to increase. However, if the yield spread increases, this suggests the increase in the bond’s yield was caused by microeconomic factors such as credit risk or the issue’s liquidity.