What a spread is
A credit spread is the extra yield a bond offers over a low-risk benchmark of similar maturity. It compensates investors for the risk of default, for lower liquidity and for uncertainty about the issuer.
Ways of measuring it
- Spread to benchmark government bond – common for US dollar bonds against US Treasuries.
- Spread to mid-swaps – standard for euro-denominated new issues.
- Z-spread – the constant spread added to the whole swap or government curve that prices the bond correctly.
- Option-adjusted spread (OAS) – a Z-spread that removes the value of embedded options such as calls.
What moves spreads
- Changes in the issuer's financial results, leverage and rating.
- Country risk, especially for emerging-market issuers.
- General risk appetite: spreads widen across the market in crises and tighten in calm periods.
- Supply: heavy new issuance can push spreads wider.
- Liquidity: small, old or rarely traded issues usually trade at wider spreads.
Comparing bonds
Comparing spreads lets an analyst judge whether a bond is cheap or expensive relative to peers with similar ratings, maturities and sectors. A spread that is much wider than peers may be an opportunity, or a sign that the market knows something the rating does not yet reflect.