Credit spread
A credit spread is the extra yield a corporate or risky bond pays over a government bond of the same maturity, compensating investors for the issuer's default risk.
See it move
A ten-year government bond yields 3.00% and a comparable ten-year corporate bond yields 5.50%. The gap, 5.50% minus 3.00%, is a 2.50 percentage point credit spread, 250 basis points, compensating investors for the issuer's default risk on top of the risk-free rate.
The formula
Variables
- Credit spread (%)
- Yield on the risky (corporate) bond (%)
- Yield on the government bond of the same maturity (%)
Gives the extra yield, usually quoted in basis points, that compensates investors for an issuer's default risk relative to a comparable government bond.
Check yourself
A ten-year government bond yields 2.8% and a ten-year corporate bond of comparable maturity from the same issuer's market yields 6.3%. The company's marginal tax rate is 30%. What is the company's after-tax cost of debt implied by this bond?