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 300 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. Nominal Yield Spread

    The nominal yield spread is the difference between a Treasury ...
  2. Credit Spread

    A credit spread is the difference between Treasury securities ...
  3. Static Spread

    The static spread is the constant yield spread above the spot ...
  4. Spread

    The difference between the bid and the ask price of a security ...
  5. Bond Equity Earnings Yield Ratio ...

    The Bond Equity Earnings Yield Ratio (BEER) is a metric used ...
  6. Intermarket Sector Spread

    Intermarket sector spread is the yield spread between two fixed-income ...
Related Articles
  1. Investing

    Corporate Bonds: An Introduction to Credit Risk

    Understand how corporate bonds often offer higher yields, and discover how it is important to evaluate the risk, including credit risk, that is involved before you buy.
  2. Investing

    Find the Right Bond at the Right Time

    Learn about the types of bonds you should consider investing in, when you should be buying them and how to compare yields against their time to maturity.
  3. Investing

    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.
  4. Investing

    Junk Bonds: A Correction May Be Looming

    Corporate debt issued by companies with riskier balance sheets and lower credit ratings typically carries higher interest rates.
  5. Investing

    Bond yield curve holds predictive powers

    This measure can shed light on future economic activity, inflation levels and interest rates.
  6. Investing

    4 basic things to know about bonds

    Learn the basic lingo of bonds to unveil familiar market dynamics and open to the door to becoming a competent bond investor.
  7. Investing

    How Often the 10-Year Yield Underperforms the S&P 500

    Learn why the S&P 500 Index dividend yield exceeds the yield on 10-year U.S. Treasurys for only the third time in history and why this trend might end soon.
  8. Investing

    How a Fed Rate Hike Will Affect Bond Markets

    As the Fed readies itself for a rate hike, investors are considering its impact across a broad variety of instruments, including equities and bond markets.
  9. Investing

    Understanding Bond Prices and Yields

    Understanding this relationship can help an investor in any market.
RELATED FAQS
  1. What causes a bond's price to rise?

    Should you invest into bonds? Learn about factors that influence the price of a bond, such as interest rates, credit ratings, ... Read Answer >>
  2. How do I use the holding period return yield to evaluate my bond portfolio?

    Find out how to use the holding period return yield formula to evaluate the performance of bonds in your portfolio, and view ... Read Answer >>
  3. What economic factors influence corporate bond yields?

    Discover the economic factors that most influence corporate bond yields, which reflect the market's assessment of a company's ... Read Answer >>
  4. Are high-yield bonds better investments than low-yield bonds?

    It depends on the amount of default risk you as an investor want to be exposed to. More yield goes hand-in-hand with more ... Read Answer >>
Trading Center