Fixed Income Investments - Types of Yield Measures

faEven though the way most investors discuss spreads is based on a Treasury security with the same maturity as the one it is being compared to, an investor can also talk about spreads between any two bonds with the following measures:

1. Absolute Yield Spread
This is the way most spreads are measured in the market. This spread measures the difference in spread between two bonds in terms of basis points.

The equation is: Yield Spread = Yield on Bond A - Yield on Bond B

2. Relative Yield Spread
This ratio measures the yield spread relative to the reference bond.
This equation is: Relative Yield Spread = Yield on bond A - Yield on Bond B/ Yield on Bond B

3. Yield Ratio
This is just the ratio of the yields between the two bonds.

The equation is: Yield Ratio = Yield on Bond A / Yield on Bond B

Market convention is to use the on-the-run government security as the reference yield or bond. So in the above equations, one would replace Bond B with the comparable government security.

Example: Yield Ratios
We want to compare an IBM five-year bond with a yield of 4.5 % and the on- the-run government five-year with a yield of 3.75%

Answer:
Absolute Yield Spread = 4.5% - 3.75% = .75% or 75 basis points

Relative Yield Spread = 4.5% - 3.75% / 3.75% = .20 = 20%

Yield Ratio = 4.5% / 3.75% = 1.20

Why Relative Spreads Are Better
Investors may find relative spreads a better measure because they measure the magnitude of the yield spread and the way it is affected by interest-rate levels. While absolute spread may be maintained as rates change, relative spreads will move in or out depending on the level of rates.

Example:
Use the IBM and Treasury bond from the previous example, except now assume that yields have increased.

Absolute Yield Spread 5.75% - 5.00% = .75% or 75 basis points. Even though yields have increased the spread is the same. However, the Relative Spread has changed too:

Answer:
5.75% - 5.00% / 5.00% = .15 or 15%.

This example shows that the relative spread can give an investor a better reading of how spreads are actually moving relative to the generic yield spread.

Intermarket vs. Intramarket Sector Spreads


Related Articles
  1. Term

    Understanding Yield Spread

    Yield spread is the difference in yields between debt instruments.
  2. Professionals

    Spreading

    Spreading
  3. Bonds & Fixed Income

    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.
  4. Bonds & Fixed Income

    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.
  5. Professionals

    Intermarket vs. Intramarket Sector Spreads

    CFA Level 1 - Intermarket vs. Intramarket Sector Spreads. Learn the various sectors that make up the bond market and how they relate to yield spreads. Also relates credit spreads to economic ...
  6. Investing Basics

    What is Spread?

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

    Options and their Benefits

    CFA Level 1 - Options and their Benefits. Learn how some options can benefit the holder of a bond, while others benefit the issuer. Relates the degree of liquidity to yield spreads.
  8. Bonds & Fixed Income

    How Bond Market Pricing Works

    Learn the basic rules that govern how bond prices are determined.
  9. Professionals

    Summary And Review

    Summary And Review
  10. Options & Futures

    Option Spreads: Tips And Things To Consider

    By John Summa, CTA, PhD, Founder of OptionsNerd.comNow that you have obtained a solid foundation for underlying option spreads, here are some tips on how to use them. In this section, we'll ...
RELATED TERMS
  1. Yield Spread

    The difference between yields on differing debt instruments, ...
  2. Intermarket Spread Swap

    A swap transaction meant to capitalize on a yield discrepancy ...
  3. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  4. Nominal Yield Spread

    The spread, expressed in percent or basis points, that when added ...
  5. Intermarket Sector Spread

    The difference in yields between two fixed-income securities ...
  6. Intramarket Sector Spread

    The yield spread between two fixed-income securities with the ...
RELATED FAQS
  1. What are the most popular and useful measures of credit spread?

    Learn about the different types of credit spread measures that measure risk, including the zero-volatility spread and the ... Read Answer >>
  2. What is the difference between the yield of stock and the yield of a bond?

    Explore and understand the various meanings of the investment term "yield" as it is applied to equity investments and bond ... Read Answer >>
  3. Can I use the current yield to compare a bond to an equity investment?

    Learn about the different types of yield measurements for stocks and bonds, and find out how to make careful comparisons ... Read Answer >>
  4. What are the different formations of yield curves?

    Find out more about the yield curve and yield curve formations, what yield curves measure and the three main types of yield ... Read Answer >>
  5. What types of stocks have a large difference between bid and ask prices?

    Find out which factors influence bid-ask spread width. Learn why some stocks have large spreads between bid and ask prices, ... Read Answer >>
  6. What are some examples of financial spread betting?

    Learn how financial spread betting is done, and see examples of some of the ways that investors can use spread betting as ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center