Yield Spread - Explained
What is a Yield Spread?
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Table of ContentsWhat is a Yield Spread?How Does a Yield Spread Work?
What is a Yield Spread?
Debt instruments with different characteristics, such as maturity date or credit/risk rating, generally have different yields. The yield spread is the difference between yields on these instruments. When the yield on a two-year treasury bond is 3%, and the yield on a 30-year treasury bond is 5%, there is a 2% yield spread. The historical data on yield spread is a great indicator of investor sentiment. It can also be used in assessing the current value of debt instruments.
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How Does a Yield Spread Work?
The yield spread on US treasuries is used as a benchmark to compare the other securities with a similar maturity date. Generally, higher-risk assets have a larger yield spread. It follows the general concept that investors expect higher reward for greater risk. An increase in the yield spread can reflect a change in comparable performance between the industries. If the yield on a high-yield corporate bond class moves up .5% and the comparable 10-year treasury bond rate remands the same, this can show that the class of corporate bonds underperformed the treasuries. Comparison of current and historical yield spreads gives an indication of how investors see current economic conditions. Contracting yield spreads tend to lead toward a flattening yield curve; conversely, widening yield spreads tend to indicate stable economic conditions and a normal yield curve.