Definition§
Yield Spread is the difference in yields between different types of debt securities. This term is most commonly used in the comparison of bonds with different credit qualities or different types of issuers. When comparing bonds, the yield spread often highlights issues of varying credit qualities because issues of similar maturity and quality typically exhibit similar yields. For instance, U.S. Treasury securities usually have the same yields if they have the same maturity and quality, hence there would be no significant yield spread.
Examples§
Example 1: Corporate vs. Treasury Bonds§
Suppose a corporate bond is yielding 5% and a U.S. Treasury bond of the same maturity is yielding 3%. The yield spread between the corporate bond and the Treasury bond is 2% (5% - 3%).
Example 2: High-Yield vs. Investment-Grade Bonds§
Consider a high-yield bond from a lesser-known tech company yielding 8% and an investment-grade bond from a well-established company yielding 4%. The yield spread in this scenario is 4% (8% - 4%).
FAQs§
What factors influence the yield spread?§
Yield spreads are influenced by various factors including credit risk, economic conditions, market demand for bonds, and investors’ risk tolerance.
How is yield spread used in investment decisions?§
Investors use yield spreads to assess the risk and potential return of different bonds. A larger yield spread indicates higher potential returns but also higher risk.
Why do Treasury bonds often have lower yields than corporate bonds?§
Treasury bonds are considered safer because they are backed by the government, which reduces their credit risk. Consequently, they offer lower yields compared to corporate bonds which have higher credit risk.
Can yield spreads change over time?§
Yes, yield spreads can fluctuate based on changes in economic conditions, market sentiment, and issuer creditworthiness.
Related Terms§
Credit Quality§
The credit quality of a bond refers to the issuer’s creditworthiness, typically rated by agencies like Moody’s, S&P, and Fitch.
Treasury Securities§
Debt securities issued by the U.S. Department of the Treasury to finance government spending. These are viewed as one of the safest investments.
High-Yield Bonds§
Bonds that offer higher yields due to their higher risk, often referred to as “junk” bonds.
Online Resources§
- Investopedia: Yield Spread Explained
- The Securities Industry and Financial Markets Association (SIFMA)
- U.S. Department of the Treasury
Suggested Books for Further Studies§
- “The Bond Book” by Annette Thau - A comprehensive guide to bond investing.
- “Handbook of Fixed Income Securities” by Frank J. Fabozzi - A thorough resource on the fixed income market.
- “Investing in Bonds For Dummies” by Russell Wild - An accessible introduction to bond investing.
Fundamentals of Yield Spread: Fixed Income Investing Basics Quiz§
Thank you for exploring the yield spread concept and testing your knowledge with our quiz. Continue to enhance your understanding of fixed income securities and make informed investment decisions!
