Yield Spread
Candlefocus EditorYield spread is often expressed as basis points or percentage points, making comparisons between various types of debt easy to understand. For example, if one bond has a yield of 7% and another bond has a yield of 9%, the difference in yield between the two bonds would be described as a two percentage point or 200 basis point spread.
The concept is significant because it can be used to examine the underlying forces driving the economy and the financial markets. Yield spreads can indicate that investors are displaying an appetite for higher risks or that investors need higher yields to compensate them for taking on added risks. Conversely, if a yield spread narrows, it can show that investors are becoming conservative, taking on less risk, and accepting lower yields.
Yield spread, then, can be used to identify changes in the economy and financial markets. Financial firms and advisors often use yield spread as a benchmark to gauge short term and long term trends in the markets and to inform their investment decisions. Yield spread can also be used as an indicator of credit strength of an idea—which can be beneficial when evaluating bonds bearing different levels of risk.
Yield spread is an important tool for investors, who can use it to better understand the underlying dynamics of a bond market and how different yields, maturities, and risk levels are affecting each other. It can also be used to compare specific instruments, such as when comparing a yield versus U. S. Treasuries or a yield versus AAA-rated corporate bonds. By paying attention to yield spreads, investors can exercise better judgment when making investment decisions.