DEFINITION of Spread-To-Worst

Spread-to-worst (STW) is the difference between the yield-to-worst of a bond and yield-to-worst of a U.S. Treasury security with a similar duration. The spread is expressed in "basis points" (bps).


The yield-to-worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. If a bond is callable, an investor runs the risk of lower returns from the bond. This is because, in an environment of declining interest rates, the bond investor would have to reinvest in lower yielding fixed income securities. Corporate bonds and municipal bonds typically have call provisions. A bond's YTW is calculated on all possible call dates prior to maturity. It is assumed that a prepayment occurs if the bond has a call option and the issuer can reissue at a lower coupon rate. The YTW is the lower of yield-to-maturity or yield-to-call. Yield-to-call is the annual rate of return assuming the bond is redeemed by the issuer on the next call date. The YTW of a premium bond is equivalent to YTC because the bond issuer is likely to call it. (A bond trading at a premium means the coupon rate is above the market yield.)

Example of Spread-to-Worst

Suppose a callable high-yield (or "junk") bond is issued with a 10-year maturity and a 5-year non-call protection provision (i.e., the issuer is not allowed to redeem the bond within five years). After three years interest rates are lower, which means there is potential for the issuer to call the bond in order to refinance at a lower coupon rate. The bond that the investor owns is now trading at a premium. The YTC is compared to the yield of a 2-year Treasury (5 years of non-call protection minus 3 years). The difference is the spread-to-worst, expressed in basis points.