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Credit Spread Definition – Explanation of How a Credit Spread Works

What is a Credit Spread?

Credit SpreadA credit spread is a difference in yield between two bonds with the same maturity.  Typically, 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.  A 1% difference in yield is equal to a spread of 100 basis points. As an example, a 10-year Treasury note with a yield of 4% and a 10-year corporate bond with a yield of 7% is said to have a credit spread of 300 basis points. Credit spreads are also referred to as “bond spreads” or “default spreads.” Credit spread allows a yield comparison between a corporate bond and a risk-free alternative.

A credit spread can also refer to an options strategy where a high premium option is written and a low premium option is bought on the same underlying security. This provides a credit to the account of the person making the two trades.

A credit spread reflects the difference in yield between a treasury and corporate bond of the same maturity. Bond credit spreads are often a good barometer of economic health.  Put simply, widening spreads are bad, and narrowing spreads are good. A credit spread can also refer to an options strategy.  A high premium option is written and a low premium option is bought on the same underlying security. A credit spread options strategy should result in a net credit, which is the maximum profit the trader can make.

(Source: investopedia.com)

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