Corporate bond spreads represent the difference in yield earned by corporate bonds and bonds issued by the United States Treasury. As the spread between the two types of bonds grows, an investor holding a corporate bond will realize a greater profit on his investment. There are many different factors which affect corporate bond spreads, with the most important of these being the credit rating of the corporation issuing the bond. Interest rates can also affect bond spreads, although there are times when other economic factors can cause interest rates and bond spreads to move independently of each other.
Investors always try to find securities which offer them the prospect of high return on their investment. In the case of bonds, which earn investors regular interest payments and eventually return the face value of the bond, that return is measured in terms of bond yield. The bond yield is affected by the interest rate on the bond, the purchase price, and market interest rates during the life of the bond. Comparing corporate bonds to Treasury bonds allows investors to study corporate bond spreads.
Treasury bonds are used as a kind of benchmark for the corporate bond spreads. Since they are backed by the US Treasury and offer great security to investors, they generally offer very small interest rates, also known as coupon rates in bond terminology. Corporations issuing bonds cannot offer the same level of security to investors, and they must compensate for this by offering higher interest payments. This creates the bond spread, which is the difference in yield between a corporate bond and a Treasury bond.
The credit ratings of the corporations offering the bonds are the most important factors in determining corporate bond spreads. In most cases, a low credit rating results in a high bond spread. But investors have to be wary of the projected spread being too high, because this can mean that the credit rating of the issuer has fallen to a point that the risk of default on bond obligations is substantial. When a default occurs, the bond holder often receives very little recompense from his bond if anything at all.
Interest rate changes can also affect corporate bond spreads. Generally, lower interest rates will increase the bond spreads, since the corporate bonds can offer higher interest rates. Other conditions may factor into bond spreads, including overall economic conditions. In difficult economic times, investors often look to the relative stability of bonds, increasing the value of bonds already held by investors.
