Yield spread

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In finance, the yield spread or "credit spread" is the difference between the quoted rates of return on two different investments, usually of different credit quality.[1]

It is a compound of yield and spread.

The "yield spread of X over Y" is simply the percentage return on investment (ROI) from financial instrument X minus the percentage return on investment from financial instrument Y (per annum).

The yield spread is a way of comparing any two financial products. In simple terms, it is an indication of the risk premium for investing in one investment product over another.[1]

When spreads widen between bonds with different quality ratings it implies that the market is factoring more risk of default on lower grade bonds.[1] For example, if a risk-free 10-year Treasury note is currently yielding 5% while junk bonds with the same duration are averaging 7%, the spread between Treasuries and junk bonds is 2%. If that spread widens to 4% (increasing the junk bond yield to 9%), the market is forecasting a greater risk of default which implies a slowing economy. A narrowing of spreads (between bonds of different risk ratings) implies that the market is factoring in less risk (due to an expanding economy).

There are several measures of yield spread, including Z-spread and option-adjusted spread.

Yield Spread Analysis[edit]





Yield spread analysis assumes that there exists a normal relationship between the yields for bonds in alternative sectors. The spread is seen to increase during periods of recession and decreases during periods of expansion. There are three ways by which spreads will be affected.

  1. Yield volatility and the behavior of embedded options
  2. The effect of yield volatility on the business cycle
  3. Yield volatility and transaction liquidity

Consumer loans[edit]

In U.S. consumer loans, particularly home mortgages, a 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 for a lender to make a loan at 6.0%, but the borrower actually takes out a loan at 6.5%, the 0.5% difference in the interest rates is the yield spread.

As the lender earns additional interest on the loan without assuming additional risk (the borrower's credit is the same), this is a source of additional profit for the lender. In order to encourage loan brokers to find borrowers who will pay yield spreads, lenders typically offer yield spread premiums to the brokers who bring them loans with yield spreads.

See also[edit]


  1. ^ a b c Michael Simkovic, Leveraged Buyout Bankruptcies, the Problem of Hindsight Bias, and the Credit Default Swap Solution Columbia Business Law Review, Vol. 2011, No. 1, p. 118, 2011