Credit spread

A credit spread is the difference between the yield on a bond with credit risk and the yield on a benchmark bond of the same maturity considered free of default risk, typically a government bond. It compensates investors for the chance the issuer fails to pay, and it widens or narrows as perceived credit risk changes.

It is calculated as Yield of the risky bond - Yield of the comparable risk-free bond, often expressed in basis points. Spreads vary by credit rating, sector, and maturity, and move along the yield curve independently of overall interest-rate levels — a bond's total yield can rise or fall from either a change in the underlying risk-free rate or a change in its spread, and the two move for different reasons, with bond duration determining how much price moves for either.

Credit spreads are a real-time market gauge of default risk and broader economic stress: spreads across the market tend to widen sharply when investors expect more defaults or a downturn, and narrow when confidence is high. Analysts use spread movements to assess an issuer's changing risk profile between formal reviews, alongside inputs such as probability of default models. A common pitfall is comparing spreads across bonds with different structural features, such as embedded options or differing liquidity, without adjusting for them, which can make credit quality look better or worse than it is.