Credit · C4 · 8 min

Spread duration, carry and breakevens

Turn a move in spreads into pounds of profit or loss, and say how much widening a bond can take before its extra yield is used up.

In the news: “Investment-grade spreads widened 15bp this week”: what that costs on a £10m holding, and whether a year of extra yield covers it.

The essentials

Spread duration: The percentage a bond’s price moves for a 100 change in its spread. For an ordinary fixed-coupon bond it is about the same as its duration: at 6, a 30bp widening costs about 1.8%.
CS01: The profit or loss for a 1bp move in spread: £10m of a bond with a spread duration of 6 has a CS01 of about £6,000. An owner is long credit, so 10bp of widening costs £60,000; a short position gains it.
Carry: The income from holding a bond while nothing moves. Against a government bond of the same maturity, a company bond earns roughly its spread extra: at 150bp over, about 1.5% a year more.
Breakeven widening: How far a spread can widen over a year before the price loss uses up the extra income: about the spread divided by the spread duration. A bond at 120bp with a spread duration of 6 can take about 20bp.
Three parts of a return: Carry, plus the move from government , plus the move from the spread. A bond yielding 5% with a duration of 6 returns about 4.4% in a year if government yields fall 20bp and its spread widens 30bp.

Spread P&L and the breakeven

CS01 ≈ N × Ds × 0.0001; breakeven ≈ s ÷ Ds

N: the amount of the bond you hold
Ds: spread duration
s: spread, in bp; the breakeven is in bp over a year

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How it works

1. Wider spread, lower price

If a company’s spread widens, its bond must yield more, so its price falls. A bond’s says by how much: with a duration of 6, a rise of one percentage point in yield costs about 6% of the price, so 30bp costs about 1.8%.

2. Spread duration

When only the spread moves, the measure is called : the % change in price for a 100bp move in spread. For an ordinary bond with a fixed coupon it is about the same as its duration.

3. CS01: the money per basis point

Now turn it into money. £10m of a bond with a spread duration of 6 moves about £10m × 6 × 0.0001 = £6,000 for each 1bp change in spread. That figure is the position’s .

4. Long or short credit

Owning the bond is being long credit: you gain when spreads tighten and lose when they widen. Selling a bond you have borrowed is being short credit, the opposite. A long position with a CS01 of £6,000 loses £60,000 if spreads widen 10bp.

5. Carry: paid to wait

Hold a bond for a year and you earn its yield even if nothing moves. That income is its . Compared with a government bond of the same length, you earn roughly the spread extra: a bond 150bp over earns about 1.5% a year more.

6. The breakeven

That extra yield is a cushion. A bond at 120bp with a spread duration of 6 can widen about 120 ÷ 6 = 20bp over a year before the price loss wipes out the extra income. That is its : spread ÷ spread duration.

7. Short and wide, or long and tight

A high spread and a short duration give the biggest cushion. A 3-year bond at 350bp with a spread duration of 2.6 can widen about 135bp; a 10-year at 120bp with a spread duration of 8 only about 15bp. The catch: the high-spread bond is far more likely to default.

8. Three parts of a return

Put it together: return ≈ carry + rates + spread. A bond yielding 5% with a duration of 6, in a year when government yields fall 20bp (+1.2%) and its spread widens 30bp (−1.8%), returns about 5 + 1.2 − 1.8 = 4.4%.

Worked example

You hold £10m of a 7-year bond near par: spread 120bp, spread duration 6.0. Over the next year its spread widens 30bp while government yields don’t move.

CS01: £10,000,000 × 6.0 × 0.0001 = £6,000 per bp.
Price loss: 30 × £6,000 = £180,000.
Extra income from the spread: 120bp × £10m = £120,000.
Breakeven: 120 ÷ 6.0 = 20bp. The move was 30bp, so you are about £60,000 down on the credit part.

About −£60,000 on the spread: 30bp of widening against a 20bp cushion.

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.

How far can spreads widen before a bond loses money over a year?
What’s CS01?
Why might an investor prefer short-dated HY to long-dated IG?

Remember

Breakeven ≈ spread ÷ spread duration

Spread is your income and spread duration your exposure: the ratio tells you how much bad news a bond can absorb.

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