Bond Yield Spread

A bond yield spread is a relative value measurement. If one bond yields 3% and another yields 4%, the spread is 100 basis points. Investors use spreads to compare bonds and identify relative value—whether one bond is “cheap” compared to another. Unlike a credit spread (which is always measured against Treasuries), a yield spread can be between any two bonds.

Yield spread vs. credit spread

These terms are related but distinct:

Yield spread is any difference in yield between two bonds. Company A’s 5-year bond yields 4%, Company B’s 5-year bond yields 4.3%—the spread is 30 basis points.

Credit spread is specifically the yield difference between a corporate bond and a Treasury of matching maturity. The 5-year Treasury yields 2.8%, Company A’s bond yields 4%, so the credit spread is 120 basis points.

Yield spreads are used for relative value. Credit spreads are used to measure credit risk premium.

Using spreads for relative value

Investors constantly ask: which bond is more attractive? Two investment-grade bonds from similar industries with similar credit ratings—which should I buy?

Compare their spreads. If both are 5-year bonds:

• Company A: Treasury + 100 bps
• Company B: Treasury + 90 bps

Company A is trading “wider” (higher spread). If their creditworthiness is truly similar, Company A is cheaper (more yield for the same risk). An investor might buy Company A, betting the spread compresses as the market reprices their relative value.

Maturity spread (yield curve slope)

Bonds of the same issuer but different maturities have different yields. The difference is the “maturity spread” or “maturity premium.” A company’s 2-year bond might yield 3%, its 10-year bond 4.2%. The 120 bp spread is compensation for the longer duration risk.

Most yield curves slope up (longer bonds yield more), but in rare cases, they invert (longer bonds yield less, signaling recession fears). The maturity spread is a key indicator of market expectations.

Sector spreads

Bonds of different sectors (utilities, banks, industrials, technology) have different spreads to comparable Treasuries, reflecting their different risk profiles. Utilities are typically “tight” (low spread, ~80–100 bps for investment-grade) because they’re stable and cash-flow predictable. Cyclicals are “wider” (~120–150 bps) because their credit quality fluctuates with the economic cycle.

Investors compare sector spreads to identify relative value. If utility spreads are 80 bps and industrial spreads are 90 bps, and you believe both have similar default risk, you might buy industrials for the extra yield.

Intra-issuer spreads

Even a single company’s bonds trade at different spreads based on seniority, maturity, and coupon. Senior bonds from a company might trade at +100 bps, while subordinated bonds from the same company trade at +200 bps. This 100 bp spread reflects the subordination risk.

Similarly, a company’s 5-year senior bond might trade at +100 bps, its 10-year senior bond at +110 bps. The 10 bp additional spread is the “term premium” for longer maturity.

Spread widening and tightening

In credit stress, spreads widen across the board. In benign markets, spreads compress. The direction and magnitude of spread moves signal market risk appetite. A 50 bp widening in investment-grade spreads is modest (normal volatility). A 300 bp widening is a panic move signaling credit stress.

When spreads widen, bond prices fall (yields rise). When spreads tighten, bond prices rise (yields fall). An investor who buys a bond at 150 bp spread and sells when the spread compresses to 100 bp realizes a capital gain, even if Treasury rates haven’t moved.

Relative value trades

Sophisticated bond investors build portfolios based on spread analysis. They might:

• Buy the “fat” sector (widest spread relative to perceived risk) and sell the “tight” sector (lowest spread).
• Buy longer maturity bonds and sell shorter maturities if the maturity spread is unusually wide.
• Buy senior bonds and sell subordinated bonds if the seniority spread is abnormally large.

These relative value trades assume spreads will eventually converge toward fair value. If they’re right, they profit; if spreads widen further, they lose.