Credit Spread Calculator
What is Credit Spread?
Credit spread, in the context of financial markets, assesses the credit quality of corporate bonds. It is the difference in yield between a corporate bond and a risk-free government bond that have the same maturity. Investors use the credit spread measure to evaluate the quality of a corporation's credit and the bonds it issues. Essentially, the wider the credit spread, the lower the company's credit quality, indicating a higher risk of default.
How to use a Credit Spread Calculator?
Using a Credit Spread Calculator involves the following steps:
Determine the Yield to Maturity (YTM) of the corporate bond: The YTM can be located on financial websites, such as Vanguard, Yahoo Finance, Fidelity, as these platforms often quote corporate bonds by their YTM. Alternatively, precise details can be found via company-specific annual reports.
Identify the YTM of a similar government bond: This information is readily available on government websites or through a simple web search. Bear in mind that it is crucial to compare the corporate bond with a government bond that has the same maturity.
Utilize the Credit Spread formula to calculate the Credit Spread:
Credit Spread = YTM of Corporate Bond - YTM of Government Bond
An actual example to demonstrate the calculator
Suppose we are evaluating a corporate bond and a government bond that both have a maturity of 10 years.
Corporate Bond Yield: 5.3%
Government Bond Yield: 1.8%
Using the Credit Spread formula:
Credit Spread = 5.3% - 1.8% = 3.5%
This means the Credit Spread is 3.5% or 350 basis points. This tells us that the Corporate Bond offers a 3.5% higher yield than the risk-free Government bond. It implies that investors expect a 3.5% higher return for the extra risk taken by investing in this corporate bond.
Additionally, it is worth noting that while Credit Spread is a useful tool, it should not be used in isolation for investment decisions. Other metrics such as the Current Ratio, Quick Ratio, Cash Flow to Debt Ratio, and Interest Coverage Ratio should also be evaluated to make a comprehensive investment decision.