For options that benefit the issuer, such as calls, investors will want yield spreads that are greater than bonds and that do not have options embedded in them. Because there is a risk that the bonds will be called, investors want a higher yield to compensate for that risk, causing the spread to widen over the treasury security when compared to bonds without options. The longer the call period, the less spread widening investors will be needed because of a longer protection period against the call.

Options That Benefit the Holder
For options that benefit the holder, such as puts, investor will require a smaller yield spread than bonds that do not have embedded options in them, such as treasury bonds. There is even the possibility that the coupon rate could be lower than the treasury coupon rate, depending on how favorable the option is to the investors.

Spreads and Liquidity
When issues are less liquid, yield spreads tend to widen because there are fewer bonds to buy or it is harder to find a buyer. When issues are more liquid, such as on-the-run treasuries, yield spreads are tighter or narrower because there are plenty of buyers and sellers.

The larger the issue size, the more liquidity compared to a smaller issues in the market leads to tighter or narrower spreads and vice versa.

After Tax Yield of a Taxable Security

Related Articles
  1. Investing

    Corporate Bonds: An Introduction To Credit Risk

    Corporate bonds offer higher yields, but it's important to evaluate the extra risk involved before you buy.
  2. Trading

    Option Spread Strategies

    Learn why option spreads offer trading opportunities with limited risk and greater versatility.
  3. Investing

    How Bond Market Pricing Works

    Yield is the commonest measure used to determine a bond’s expected return. Yield-to-maturity and spot rates are the two primary yield measures.
  4. Trading

    Explaining Credit Spread

    A credit spread has two different meanings, one referring to bonds, the other to options.
  5. Investing

    How To Calculate The Bid-Ask Spread

    It's very important for every investor to learn how to calculate the bid-ask spread and factor this figure when making investment decisions.
  6. Investing

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
  7. Investing

    What is Spread?

    Spread has several slightly different meanings depending on the context. Generally, spread refers to the difference between two comparable measures.
  8. Investing

    Guide To Embedded Options In Bonds

    Investors should be aware of embedded options that may be available in certain securities as these options may affect the value of the security.
Frequently Asked Questions
  1. How did the ABX index behave during the 2008 subprime mortgage crisis?

    Read about the disastrous performance of the various ABX indexes in the subprime mortgage crisis of 2008 during the middle ...
  2. How did moral hazard contribute to the 2008 financial crisis?

    Learn about moral hazard, how it can affect outcomes and how it contributed to the conditions that led to the 2008 financial ...
  3. Which mutual funds made money in 2008?

    Read about the only mutual fund that turned a profit in 2008. Learn about risk-averse investment strategies and the financial ...
  4. Were Collateralized Debt Obligations (CDO) Responsible for the 2008 Financial Crisis?

    Collateralized debt obligations are exotic financial instruments that can be difficult to understand, Learn the role they ...
Trading Center