Investing

Yield Curves, Credit and Credit Spreads

Bond Market Technical Jargon Explained:

You may have heard bond market jargon like ‘yield curves’ and ‘credit spreads’ along with other technical terms and acronyms.  Like equity markets, the bond market has its own jargon that can be confusing. Yield curves, credit and credit spreads are commonly used Jargon, so it’s worth spending a couple of minutes on what these terms mean.

Yield Curves

A yield curve is a line that plots yields for bonds with the same credit quality but different maturity dates. You will have read about the Government bond yield curve in the media as it is commonly referenced as a baseline for many markets. There are government bonds at regular maturity points and because they are issued by the Australian Government they are considered default risk free. The government bond yield curve is particularly useful when comparing ‘credit spreads’ of corporate bonds.

Credit

The terms Credit, Credit Analyst, Credit Trader and Credit Sales Team can be confusing and sound like they have something to do with credit cards.  ‘Credit’ is the bond market name for corporate debt and even the bond issuers themselves.  So BHP and Telstra are ‘Credits’.  They issue bonds to investors – so they’re the creditor from the bond investor’s perspective. A credit sales desk sells corporate bonds – not credit cards.

Credit Spreads

‘Credit Spread’ is another very common bond market term, and an equities person would be excused for thinking of the bid-offer spread of a security on ASX when they think of the word ‘spread’.  But Credit Spread has another meaning for bonds.

Credit Spreads are important because we make investments using comparisons. Credit spreads give investors another tool to make an investment decision and help to identify how much they are being compensated for investing in a corporate bond instead of a government bond.

Rather than describing yields on bonds in isolated or absolute terms, it is very common to talk about the differences in yields, or the ‘spread’ of one type of bond compared to another.

For example, if a 3-year government bond was trading at a yield of 2.5% and a 3-year BBB-rated corporate bond was trading at a yield of 4.5%, then the corporate bond would be said to be trading at a 2% or 200 bps spread to the government bond.

 

If the market said 1, 3, 5, and 7 year BBB rated corporate bonds were trading at a spread to government bonds of 200 bps, then all things being equal, the yields on the 4 corporate bonds of different maturities will be 200bps above the yields of their respective government bonds on the curve.

The phrase ‘credit spreads have widened’, means the difference or spread between the government yield curve and the corporate yield curve has increased.  ‘Credit spreads have widened’ is a relative term that gives you no clue as to what has happened to a bond’s absolute yield.  It simply tells you that the corporate bond has underperformed its nearest benchmark government bond.

In fact, both the corporate bond and the government bond could have fallen in yield (both prices have increased), but the government bond’s yield could have fallen more, and so it outperformed the corporate bond and so the spread between them widened.

Jargon can be daunting for end investors and advisers alike.  Yield Matters will provide similar short pieces on bond market jargon from time to time to provide advisers with the tools needed to explain corporate bonds in simple terms to your clients.

Contact Us

If you have any particular questions, please contact us via at advisers@xtbs.com.au or 1800 995 993.

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