Credit spreads

I have had trouble lately with identifying buy and sell signals related to credit spreads. For example, if the credit spread between a corporate bond and the US 10 year has widened does that constitute a buy/sell signal? I think its a buy signal because rates move inversely with price. Therefore, the corporate debt becomes cheaper? Does that logic follow?

Credit spread = US 10 Year Yield - Corporate Bond Yield.

if Credit Spread widened - the Corporate Bond yield REDUCED. So Corporate bond became MORE expensive. So you would sell it…

I understand your logic, but shouldn’t it be the other way around?

So… credit spread = Corporate Bond Yield - US 10 Year Yield.

Therefore, a wider spread would mean the yield on the corporate bond increased?

I’m sure cpk123 can explain why this is wrong, but this is what I thought as well. Basically, my thinking is…

Widening spreads mean economic conditions are worsening, so investors need more compensation for the risk of lending to a corporation, so the yields will go up on corps and get smaller on govs as money flows out of corps and to the safety of UST’s. Therefore, it’s a sell signal that the market is worsening. In the market, everything is related to bond prices. Widending spreads would indicate prices are going down. To me, that’s a sell signal.

Spread = US treasury - Corp … not the other way around …

No, I’m pretty sure you’re incorrect on this one. The credit spread or ‘yield spread’ is the absolute value of the difference in yield between the corporate bond and the government bond. Your comment that…" if Credit Spread widened - the Corporate Bond yield REDUCED" just isn’t correct. Widening credit spreads mean that yields on corp bonds go up. You can calculate that spread as ust - corp if you want, but it’s the absolute value that matters.

LOS 53.i: Compare, calculate, and interpret yield spread measures.

A yield spread relative to a benchmark bond is known as a benchmark spread. For example, if a 5-year corporate bond has a yield of 6.25% and its benchmark, the 5-year Treasury note, has a yield of 3.50%, the corporate bond has a benchmark spread of 625 – 350 = 275 basis points.

According to your formula the US treasury has a higher yield than the corporate bond? Or am I interpreting this incorrectly? Because surely the credit spread refers to the spread over the government bond (Not the corporate bond as you are implying). If the spread widens then surely that means the corporate debt yield increases? How can it decrease?

His formula only makes sense if you take the absolute value. The yield on a corp is always going to be higher than a benchmark risk free bond, like a treasury, so his formula will always end up with a negative value.

CPK 123 I am sorry but that is definitely incorrect. If spreads widen then corporate yields increase as credit risk posed has increased. If spreads widen then its a sell signal as prices are declining. Maybe S2000 magician can clear this up?

The spread is defined as the difference between the yield on an instrument and the yield on a benchmark instrument (usually a Treasury). In this case, since the risky security has a higher yield, for the spread to widen, the yield on the risky security must increase.

To calculate the spread you either take (risky security - Treasury) or the absolute value of (Treasury - risky) – or for that matter the absolute value of risky-treasury.

But I’ve never seen the spread expressed as CPK has done it - either in practice or in ANY finance textbook that covers the topic.

my bad … and thanks all, for correcting me …

so hope I am writing the right thing now.

credit spread is the difference between the bond’s yield and US treasury bond of the same maturity.

credit spread widening - lower grade bond’s yield increases - and therefore it’s price is dropping. (worse economic fundamentals)

so the bond’s grade quality is moving towards that of lower than investment grade.

so you would sell that to get it off your investments.

Widening spreads mean that the market is demanding more to lend to ‘riskier’ corporate bonds, so the price of corp bonds is going down and yield are going up. As far as I know, it’s seen as a general signal of market trouble and is usually discussed in relation to the corp bond market as a whole, rather than to partiuclar individual bonds. The yield spread on a bond is certainly a measure of it’s riskiness, but when people talk about ‘credit spreads widening’, it’s usually in the context of the market or a subset of the market, rather than individual bonds.