measuring yield spreads, Financial Management

A yield spread between any two bond issues can be easily computed when the maturity date for both these issues is same.

The yield spread between these two bond issues, say bond A and bond B, is calculated as follows:

         Yield Spread = Yield on bond A - Yield on bond B

Here, bond B is considered to be a benchmark against which bond A is measured.

When a yield spread is calculated by applying the above formula, it is referred to as an absolute yield spread. It is measured in basis points. For example, on the basis of Table 1, as on 03.07.2007, the yield on a 5-year on-the-run treasury issue was 4.87% and the yield on a single A-rated 5-year industrial bond was 7%. If bond A is the 10-year industrial bond and bond B is the 10-year on-the-run treasury issue, the absolute yield spread is:

         Yield Spread = 7% - 4.87% = 2.13% or 213 basis points.

Unless otherwise specified, yield spreads are measured by applying the
above-mentioned formula. Yield spread may also be computed on a relative basis by taking the ratio of the yield spread to the yield of the reference bond. This is called a relative yield spread.

        1345_measuring yield spread.png   

 

Sometimes, bonds are compared in terms of a yield ratio, the quotient of two bond yields, as shown below: 

        1264_measuring yield spread1.png   

 

 Let us assume that Bond B is the benchmark Treasury issue; then the equations for the yield spread measures are as follows:  

       Absolute yield spread  = Yield on bond A - Yield of on-the run treasury 

       Relative yield spread =   1209_measuring yield spread2.png   

     Yield Ratio                =  1560_measuring yield spread3.png   

 

Considering the above example, let us compare the yields on the 5-year single A-rated industrial bond and the 5-year on-the-run treasury; the relative yield spread and yield ratio are computed below:  

       Absolute yield spread = 7% - 4.87% = 2.13% = 213 basis points 

       610_measuring yield spread4.png

Posted Date: 9/10/2012 3:13:00 AM | Location : United States







Related Discussions:- measuring yield spreads, Assignment Help, Ask Question on measuring yield spreads, Get Answer, Expert's Help, measuring yield spreads Discussions

Write discussion on measuring yield spreads
Your posts are moderated
Related Questions
Q. Factors Determining Dividend Policy? (1) Financial Needs of the Firm: - Financial requirement of a firm are directly related to the investment opportunities available to it.

Q. What is the significance of Working Capital? Meaning of Working Capital: - Working capital management is an significant aspect of financial management. In business money is

Explain how the cash budget and the capital budget relate to pro forma financial statements. The cash budget demonstrates the projected flow of cash in and out of the firm fo

Partial Income Statement Year Ending 2011 Sales Revenue                $350,000 COGS                            $140,000 Fixed Costs                     $ 43,000 SG&A E

Would exchange rate changes all time increase the risk of foreign investment? Discuss the condition within which exchange rate changes may actually decrease the risk of foreign inv

Q. Explain Systematic Risks in Financial management? Systematic risk in non-diversifiable and is associated with the securities Market as well as economic, sociological, politi

The managing directors of three profitable listed companies discussed their companies' dividend policies at a business lunch. Company A ; has deliberately paid no dividends for

Takeover, Inc. is a Delaware corporation whose only stated purpose is to acquire companies.  It has virtually no assets and no employees other than the original founders who contri

We can discount cash flows either by using spot rates or forward rates, because a spot rate is simply a package of short-term forward rates. Assume that the cash

Q. Show External business risk? External risk is the result of operating conditions imposed on the firm by circumstances beyond its control. The external environments in which