High-Yield Bond Spread

What Is a High-Yield Bond Spread?

A high-yield bond spread is the percentage difference in current yields of different classes of high-yield bonds compared against investment-grade corporate bonds, Treasury bonds, or another benchmark bond measure. Spreads are in many cases communicated as a difference in percentage points or basis points. The high-yield bond spread is additionally alluded to as credit spread.

How a High-Yield Bond Spread Works

A high-yield bond, otherwise called a junk bond, is a type of bond that offers a high rate of interest in light of its high risk of default. A high-yield bond has a lower credit rating than government bonds or investment-grade corporate bonds, yet the higher interest income or yield attracts investors to it. The high-yield sector has a low correlation to other fixed income sectors and has less sensitivity to interest rate, making it a wise investment asset for portfolio diversification.

The greater the default risk of a junk bond, the higher the interest rate will be. One measure that investors use to evaluate the level of risk inherent in a high-yield bond is the high-yield bond spread. The high-yield bond spread is the difference between the yield for low-grade bonds and the yield for stable high-grade bonds or government bonds of comparative maturity.

As the spread increases, the perceived risk of investing in a junk bond likewise increases, and thus, the potential for earning a higher return on these bonds increases. The higher yield bond spread is, subsequently, a risk premium. Investors will face the higher risk challenges in these bonds in return for a premium or higher earnings.

High-yield bonds are commonly assessed on the difference between their yield and the yield on the U.S. Treasury bond. A company with weak financial wellbeing will have a relatively high spread relative to the Treasury bond. This is rather than a financially strong company, which will have a low spread relative to the US Treasury bond. Assuming Treasuries are yielding 2.5% and low-grade bonds are yielding 6.5%, the credit spread is 4%. Since spreads are communicated as basis points, the spread, in this case, is 400 basis points.

High-yield bond spreads that are more extensive than the historical average recommends greater credit and default risk for junk bonds.

Benefits of High-Yield Bond Spreads

High-yield spreads are utilized by investors and market analysts to assess the overall credit markets. The change in the perceived credit risk of a company brings about credit spread risk. For instance, on the off chance that lower oil prices in the economy negatively influence many companies, the high-yield spread or credit spread will be expected to broaden, with yields rising and prices falling.

On the off chance that the general market's risk tolerance is low and investors explore towards stable investments, the spread will increase. Higher spreads show a higher default risk in junk bonds and can be an impression of the overall corporate economy (and in this way credit quality) as well as a more extensive weakening of macroeconomic conditions.

The high-yield bond spread is most helpful in a historical setting, as investors need to know how wide the spread is today compared to the average spreads in the past. Assuming the spread is too narrow today, many astute investors will try not to get involved with junk bonds. High-yield investments are alluring vehicles for investors on the off chance that the spread is more extensive than the historical average.

Highlights

• A high-yield bond spread, otherwise called a credit spread, is the difference in the yield on high-yield bonds and a benchmark bond measure, for example, investment-grade or Treasury bonds.
• High-yield bonds offer higher yields due to default risk. The higher the default risk the higher the interest paid on these bonds.
• High-yield bond spreads are utilized to assess credit markets, where rising spreads can signal weakening macroeconomic conditions.