# What is a default spread?

The term default spread can be defined as the difference between the yields of two bonds with different credit ratings. The default spread of a particular corporate bond is often quoted in relation to the yield on a risk-free bond such as a government bond for similar duration.

The default spread is usually defined as the yield or return differential between long-term BAA corporate bonds and long-term AAA or U.S. Treasury bonds. 2 However, as Elton et al. (2001) show, much of the information in the default spread is unrelated to default risk.

Similarly, how do you find the default spread? The cost of debt for a company is then the sum of the riskfree rate and the default spread:

1. Pre-tax cost of debt = Risk free rate + Default spread.
2. The default spread can be estimated from the rating or from a traded bond issued by the company or even a company CDS.

As we can see, this method takes the Country Default Spread (Sovereign yield spread) as a measure of the general country risk and then adjusts it for the volatility of stock market relative to the bond market. The country default spread can also be observed using the country ratings.

The term spread measures the difference between the coupons, or interest rates, of two bonds with different maturities or expiration dates. If the term spread is positive, the long-term rates are higher than the short-term rates at that point in time and the spread is said to be normal.

### How do you calculate the spread?

The calculation for a yield spread is essentially the same as for a bid-ask spread – simply subtract one yield from the other. For example, if the market rate for a five-year CD is 5% and the rate for a one-year CD is 2%, the spread is the difference between them, or 3%.

A risk spread is a premium for bearing economic risk of an investment, paid over and above the short-term real interest rate.

The Zero-volatility spread (Z-spread) is the constant spread that makes the price of a security equal to the present value of its cash flows when added to the yield at each point on the spot rate Treasury curve where cash flow is received.

### What is the 2/10 spread?

The 10-2 Treasury Yield Spread is the difference between the 10 year treasury rate and the 2 year treasury rate. A negative 10-2 spread has predicted every recession from 1955 to 2018, but has occurred 6-24 months before the recession occurring, and is thus seen as a far-leading indicator.

### What is a spread in bonds?

The term “bond spreads” or “spreads” refers to the interest rate differential between two bonds. Mathematically, a bond spread is the simple subtraction of one bond yield from another. Bond spreads reflect the relative risks of the bonds being compared. The higher the spread, the higher the risk usually is.

### Why is yield spread important?

Yield on non-government/individual bonds = RFR + Yield spread. Now why yield spread is such an important measure: Because bond yields are always in motion, so too are spreads. The direction of the yield spread can increase, or “widen,” which means that the yield difference between two bonds or sectors is increasing.

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality. Credit spreads between U.S. Treasuries and other bond issuances are measured in basis points, with a 1% difference in yield equal to a spread of 100 basis points.

### What is the current credit spread?

Historically, the average credit spread between 2-year BBB-rated corporate bonds and 2-year U.S. Treasuries is 2%. The current spread is 3% (5% – 2%).

### How is risk free rate calculated?

To calculate the real risk-free rate, subtract the current inflation rate from the yield of the Treasury bond that matches your investment duration. If, for example, the 10-year Treasury bond yields 2%, investors would consider 2% to be the risk-free rate of return.

### What is risk free rate of return?

The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time.

### How is risk premium calculated?

The risk premium is calculated by subtracting the return on risk-free investment from the return on investment. Risk Premium formula helps to get a rough estimate of expected returns on a relatively risky investment as compared to that earned on a risk-free investment.

### How is country risk calculated?

Calculating Country Risk Premium Yield on Country A’s 10-year USD-denominated sovereign bond = 6.0% Yield on US 10-year Treasury bond = 2.5% Annualized standard deviation for Country A’s benchmark equity index = 30% Annualized standard deviation for Country A’s USD-denominated sovereign bond index = 15%

### What is the difference between risk premium and market risk premium?

The difference between a market-risk premium and an equity-risk premium comes down to scope. The market risk premium is the additional return that’s expected on an index or portfolio of investments above the given risk-free rate. Equity-risk premiums are usually higher than standard market-risk premiums.

### How do you read Beta?

A beta that is greater than 1.0 indicates that the security’s price is theoretically more volatile than the market. For example, if a stock’s beta is 1.2, it is assumed to be 20% more volatile than the market. Technology stocks and small caps tend to have higher betas than the market benchmark.