Credit · C3 · 8 min
Credit spreads and quoting
Turn a bond’s yield into a spread and back, and split a day’s move into the part from interest rates and the part from credit.
In the news: “The deal priced at T+95” and “spreads widened on recession fears”: what each quote means for a company bond’s yield.
The essentials
- Credit spread
- The extra a company bond pays over a government bond of the same maturity, for the risk of not being repaid. It is quoted in : “T+150” is 150bp over the matching US Treasury.
- G-spread and I-spread
- The is measured over the government bond, the over the . With swaps below , the I-spread is larger: a 5.85% bond is 125bp over a 4.60% gilt and 145bp over a 4.40% swap rate.
- Spread or price
- Investment-grade bonds are quoted on spread, and the price follows from the benchmark. High-yield and distressed bonds are quoted on price, because the chance of default, not the government rate, drives their value.
- Splitting a move
- A company bond’s yield moves with its benchmark and with its spread. If government yields fall 20bp while the spread widens 10bp, the yield falls 10bp: the rates move outweighed the credit move.
- What widens spreads
- Recession fears, falling profits or rising debt at the company, heavy new issuance, and money leaving credit funds; the reverse tightens them. In a sell-off, flows can push spreads further than the default outlook justifies.
Spread and yield
yield = benchmark yield + spread
- benchmark
- the government bond of the same maturity (G-spread) or the swap rate (I-spread)
- spread
- the extra yield for the company’s risk, in bp (100bp = 1%)
How it works
1. Two borrowers, two rates
The UK government can borrow for ten years at, say, 4%. A company borrowing for ten years must pay more, say 5.5%, because it might not pay back. The gap of 1.5 percentage points is the company’s : the extra yield for taking its risk instead of the government’s.
2. Quoting in basis points
Traders quote spreads in (bp), hundredths of a percentage point. So a spread of 1.5 points is 150bp. “T+150” means 150bp over the US Treasury of the same maturity.
3. Yield = benchmark + spread
Turn it round and you can price a new bond. If gilts yield 4.10% and investors want 120bp, the new bond must yield 4.10% + 1.20% = 5.30%. A spread measured against a government bond like this is the .
4. Against swaps instead
Many investors measure spread against the swap rate instead: the fixed rate paid in an , the standard contract for swapping fixed for floating interest. That spread is the . If swap rates sit below government yields, the I-spread is the bigger of the two.
5. Safe bonds on spread, risky bonds on price
For a safe company, most of its yield is the government rate, so traders quote the spread and let the price follow. For a risky company, the chance of default drives everything and prices can sit far below 100, so traders quote the price itself.
6. What moves spreads
Spreads widen when recession fears grow, when a company’s profits fall or its debt rises, when many new bonds are being sold, and when investors pull money out of credit funds. They tighten on the reverse.
7. Splitting a move
A company bond’s yield moves when either part moves. If Treasury yields fall 20bp and the spread widens 10bp, the bond’s yield falls 10bp: the rates move won. Splitting each move this way shows whether rates or credit drove it.
8. From yield to price
A bond’s turns a yield move into a price move. With a duration of 7, each 10bp rise in yield costs about 0.7% of the price, and a 10bp fall gains about the same. So when the yield falls 10bp, a duration-7 bond gains about 0.7%.
Worked example
Say a 10-year sterling company bond yields 5.85%, the 10-year gilt 4.60% and the 10-year swap rate 4.40% (illustrative). Then gilt yields fall 15bp and the bond’s spread widens 10bp. Its duration is 7.5.
- G-spread: 5.85% − 4.60% = 1.25 points = 125bp.
- I-spread: 5.85% − 4.40% = 145bp, bigger because swaps sit below gilts.
- Yield change: −15bp + 10bp = −5bp, so the new yield is 5.80%.
- Price change: 7.5 × 0.05% ≈ +0.38%.
The yield falls 5bp and the price rises about 0.4%: rates helped by 15bp, credit hurt by 10bp.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
Why do IG bonds trade on spread and HY bonds on price?
Treasuries rally but spreads widen. What happens to a corporate bond?
What makes credit spreads widen?
Remember
Yield = benchmark + spread
Every company bond is a rates trade and a credit trade: split each move into the benchmark and the spread.