Coupon vs residual

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North Carolina. North Dakota. Spreads seem simple but reflect a lot of underlying valuation factors. Here are some of the spreads that can be calculated, as well as their commonly understood meaning:.

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Credit Spreads are the differences in interest rates that reflect the credit risk between two bonds. Corporate bonds generally have higher yields than similar maturity federal government bonds, as in our Sears Canada example above, reflecting their higher default or credit risk.

The lower the credit quality and rating, the higher the yield spread compared to governments. Term or Duration Spreads are the spreads that reflect the different interest rates between bonds of different maturity. For example, the current interest rate on the very short-term, two year Canada bond in our example is 4. Coupon Spreads are spreads that reflect the differences between bonds with different interest rate coupons. Right now, these bonds trade 10 bps apart in yield, reflecting the difference in coupon and liquidity.

At one time, there was a very large difference in coupons of over. The residual trades at a wider spread , reflecting its lower liquidity. Investment strategists use the spreads between the dividend yield and earnings yields on stocks and bond yields in their judgments on the relative attractiveness of these markets. Traders use yield spreads as their benchmark for valuing bonds.

Most traders have computer trading systems, such as Bloomberg and PC Bond which allow them to quickly calculate historical and actual spreads between many different bonds.

Consider a yield spread increase. This increases its relative interest rate. We start with the Canada 9. This makes a new interest rate of 5. The opposite would be true for a spread tightening. The investor who bought at the issue spread of bps in and sold at bps in received additional spread of 3. The savvy investor who bought in and has held to has an excess spread of Below we subtract the Canada yield from the Sears yield to obtain the spread : 5.