When multiple parties are buying and selling certain kinds of assets or securities, a spread indicator tracks the margin or spread between the highest and lowest prices that individuals are willing to pay for the item. Various types of spread indicator are used to track margins involving stock and bonds sales. Other types of spread indicators are used to track bank loan rates.
Thousands of different stocks are registered and sold on exchanges around the world. Every time one of these securities changes hands, a buyer and a seller have to negotiate a sale price. The lowest price that a seller is prepared to accept for a security is called the ask price, while the price that an investor is willing to pay for the same security is called the bid price. In terms of stock trading, investors use a spread indicator to keep track of the margin between the lowest ask price and the highest bid price. Trade negotiations involve a buyer and seller agreeing on a price that falls somewhere within the spread margin.
Investors also review margins involving bonds before purchasing debt securities. In many countries, bonds issued by the national government are viewed as being more stable than municipal debts since national governments are historically less likely to default on loans than regional governments. Likewise, corporate bonds are often characterized as being riskier investments than government bonds while mortgage-backed securities are seen by many as being the riskiest bond investments of all. National governments, municipalities, corporations and mortgage investment firms all issue bonds with terms that may last for five, 10 or even 30 years. A bond spread indicator measure the difference in the yield or interest rate that different types of bond issuers have to pay.
Lenders such as banks and mortgage firms also use spread indicators to keep track of loan rates. These institutions raise funds to write loans by borrowing money from central banks or from deposit account holders. Lending institutions mark-up these loans before allowing business and consumer investors to borrow the money. The spread indicator tracks the bank's profit margin on writing the loan since the low end of the spread represents the price the bank paid to borrow the money; the high end of the spread represents the amount that bank's charge other parties to borrow this same money.
Investors use spread indicators to make investment decisions. If a low risk bond has a similar yield to a high-risk bond then there is very little incentive to buy the risky security. Aside from using these indicators to make investment decisions, analysts use spread indicators to determine the health of the economy. When the spread between ask and bid prices of stocks or low risk and high-risk bonds is very large, then it suggests that investor are wary of taking risk and that the economy is entering a downturn.
