Spread-to-Worst

What is Spread-To-Worst?

Spread-to-worst (STW) measures the dispersion of returns between the best and worst performing security in a given market, generally bond markets, or between returns from various markets.

Understanding Spread-To-Worst (STW)

STW in bond markets is the difference between the yield-to-worst (YTW) of a bond and yield-to-worst of a U.S. Treasury security with comparable duration. The STW is either yield-to-call (YTC) or yield-to-maturity (YTM), whichever is lower, and is communicated in "basis points (bps)."

STW utilizes the YTW, which is the lowest potential yield that can be received on a bond without the issuer really defaulting. On the off chance that a bond is callable, an investor runs the risk of lower returns from the bond. This is on the grounds that, in an environment of declining interest rates, the bond investor would need to reinvest in lower-yielding fixed income securities. Corporate bonds and municipal bonds typically have call provisions.

A bond's YTW is calculated on all conceivable call dates prior to maturity. It is assumed that a prepayment happens assuming that the bond has a call option and the issuer can reissue at a lower coupon rate. The YTW is the lower of YTC or YRM. YTC is the annual rate of return accepting the bond is redeemed by the issuer on the next call date. The YTW of a premium bond is equivalent to YTC on the grounds that the bond issuer is probably going to call it. A bond trading at a premium means the coupon rate is over the market yield.

Applying STW to various markets can guide an investor to pursue choices that could upgrade their portfolio's value. For instance, if STW among equities and U.S. treasuries was high, say more than 40%, then, at that point, the investor should think about slanting their portfolio's weighting towards equities. Just like with most market receptive measures, STW will is intensely dependent on factors, for example, short-or long-term interest rates, investor confidence, and other comparative metrics.

Special Considerations

Sorting out which is lower should be possible rapidly by understanding a few tips. To start with, in the event that a bond is callable, there will be a YTC. If not, YTM is the de facto lowest yield and will be utilized for STW. Be that as it may, assuming the bond is callable and it trades at a premium to par value, the YTC will be lower than YTM.

Callable bonds are no doubt called when interest rates are low. The yield on callable bonds is typically higher in view of the risk that investors should reinvest the proceeds at a lower interest rate, otherwise called reinvestment risk.

Illustration of Spread-to-Worst (STW)

Assume a callable high-yield bond is issued with a 10-year maturity and a five-year non-call protection provision (i.e., the issuer isn't allowed to redeem the bond in five years or less). Following three years, interest rates are lower, and that means there is potential for the issuer to call the bond to refinance at a lower coupon rate.

The bond that the investor possesses is presently trading at a premium. The YTC is compared to the yield of a two-year Treasury — five years of non-call protection minus the three years that have passed. The difference is the STW, communicated in basis points.

Highlights

• Spread-to-worst (STW) measures the dispersion of returns between the best and worst performing security in a given market, generally bond markets, or between returns from various markets.
• STW in bond markets is the difference between the yield-to-worst (YTW) of a bond and the yield-to-worst (YTW) of a U.S. Treasury security with comparable duration.
• Applying spread-to-worst to various markets can guide an investor in settling on choices that could streamline their portfolio's value.