Credit Spread
IntermediateA credit spread is the difference between the yield on a bond with credit risk, such as a corporate bond, and the yield on a government bond of similar maturity that is considered safe.
Investors demand extra return for lending to borrowers who might not repay. The credit spread measures that extra return. It is usually expressed in percentage points or in basis points, where 100 basis points equals one percentage point.
For example, if a five-year corporate bond yields 6% and a five-year government bond yields 4%, the credit spread is 2 percentage points, or 200 basis points.
Credit spreads reflect the market's view of default risk. Financially strong companies have narrow spreads, while weaker companies have wide ones. Spreads also change with the economy. In good times, investors are confident and spreads narrow. In recessions or financial crises, fears of defaults rise and spreads widen sharply.
Because of this, credit spreads are watched as an indicator of financial stress. For companies, wider spreads mean higher borrowing costs. For bond investors, a widening spread means the prices of their corporate bonds are falling relative to government bonds.
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