Spread

published 14 May 2018

Updated July 2018

"Spread" is a bit of financial jargon you'll read in several contexts. It simply means the gap between one price and another. So for example, in the equity market you'll often hear about the "bid-offer spread". This is the gap between the price at which you can sell a share and the price at which you can buy it. The spread in this case is in effect another trading cost you have to consider when buying or selling shares.

However, "spread" is also used in the bond market in connection with a somewhat different concept. A "credit spread" is the difference in yields between two bonds of similar maturities (in other words, two bonds that are due to repay their face value at roughly the same time), but different credit ratings. The credit spread effectively shows how much extra yield investors are demanding in exchange for taking more risk by lending their money to a borrower with a lower credit rating.

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For example, right now highly risky debt issued by electric carmaker Tesla, due to be repaid in 2025, yields around 7.9%. A comparable US Treasury (an IOU issued by the US government debt, widely viewed as the least-risky borrower in the market) yields around 2.9%. So the "credit spread" is around four percentage points, or 400 "basis points" in the jargon (a single basis point is 0.01%).

When credit spreads widen, it shows that the market is becoming more concerned about credit quality. For example, before the 2010 eurozone crisis, government debt issued by eurozone countries, from Greece to Germany, tended to offer similar yields the "spread" between them was very tight. But once the crisis hit, and lenders realised that Germany wasn't necessarily prepared to stand behind Greek debt and make them whole, spreads widened sharply ("blew out", in the jargon), as the market again started to differentiate between nations based on credit risk.