Yield Spread

Loading the player...

What is a 'Yield Spread'

A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings and risk, calculated by deducting the yield of one instrument from another. For example, if the five-year Treasury bond is at 5% and the 30-year Treasury bond is at 6%, the yield spread between the two debt instruments is 1%. If the 30-year bond is trading at 6%, then based on the historical yield spread, the five-year should be trading at around 1%, making it very attractive at its current yield of 5%.

BREAKING DOWN 'Yield Spread'

The yield spread is a key metric that bond investors use when gauging the level of expense for a bond or group of bonds. For example, if one bond is yielding 7% and another is yielding 4%, the spread is three percentage points, or basis points (BP). Non-Treasury bonds are generally evaluated based on the difference between their yield and the yield on a Treasury bond of comparable maturity.

Yield Spread and Risk

Typically, the higher risk a bond or asset class carries, the higher its yield spread. When an investment is viewed as low-risk, investors do not require a large yield for tying up their cash. However, if an investment is viewed as higher risk, investors demand adequate compensation through a higher yield spread in exchange for taking on the risk of their principal declining. For example, a bond issued by a large, financially healthy company typically trades at a relatively low spread in relation to U.S. Treasuries. In contrast, a bond issued by a smaller company with weaker financial strength typically trades at a higher spread relative to Treasuries. For this reason, bonds in emerging markets and developed markets, as well as similar securities with different maturities, typically trade at significantly different yields.

Yield Spread Movements

Because bond yields are often changing, yield spreads are as well. The direction of the spread may increase or widen, meaning the yield difference between two bonds is increasing, and one sector is performing better than another. When spreads narrow, the yield difference is decreasing, and one sector is performing more poorly than another. For example, the yield on a high-yield bond index moves from 7% to 7.5%. At the same time, the yield on the 10-year Treasury remains at 2%. The spread moved from 5 BP to 5.5 BP, indicating that high-yield bonds underperformed Treasuries during that time period.

When compared to the historical trend, yield spreads between Treasuries of different maturities may indicate how investors are viewing economic conditions. Widening spreads typically lead to a positive yield curve, indicating stable economic conditions in the future. Conversely, when falling spreads contract, worsening economic conditions may be coming, resulting in a flattening of the yield curve.

RELATED TERMS
  1. Credit Spread

    1. The spread between Treasury securities and non-Treasury securities ...
  2. Spread

    1. The difference between the bid and the ask price of a security ...
  3. Yield Curve Risk

    The risk of experiencing an adverse shift in market interest ...
  4. Intermarket Sector Spread

    The difference in yields between two fixed-income securities ...
  5. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  6. Intermarket Spread Swap

    A swap transaction meant to capitalize on a yield discrepancy ...
Related Articles
  1. Markets

    Understanding Yield Spread

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

    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.
  3. Markets

    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. Managing Wealth

    How Bond Market Pricing Works

    Learn the basic rules that govern how bond prices are determined.
  5. Managing Wealth

    Find The Right Bond At The Right Time

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

    What is Spread?

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

    Understanding the Different Types of Bond Yields

    Any investor, private or institutional, should be aware of the diverse types and calculations of bond yields before an actual investment.
  8. Trading

    Explaining Credit Spread

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

    Bond Basics: Yield, Price And Other Confusion

    Investopedia Explains: Bond yield, Bond price, yield to maturity, the link between price and yield and bond price in the market.
  10. Trading

    Finding The Best Yields

    Using yields to supplement earnings can mean big bucks, with the right strategy.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. Why are treasury bond yields important to investors of other securities?

    Learn about the wide-ranging impact of U.S. Treasury Bond yields on all other interest-bearing instruments in the economy ... Read Answer >>
  6. What are some classes I can take to prepare for the Series 6 exam?

    Learn about how the risk-return tradeoff applies to bond yields, and the different types of risks associated with investing ... Read Answer >>
Hot Definitions
  1. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  2. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  3. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  4. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  5. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  6. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
Trading Center