Reading more about bond selection and keep seeing the phrase credit spread. I understand yield but credit spread is less clear. Is it just the yield difference between two bonds? Or something more specific? And why does it matter practically before buying? Disc: trying to build a proper evaluation framework.
Credit spread is the yield difference between a corporate bond and a risk-free government bond of the same maturity. It represents what the market is charging the corporate issuer above the risk-free rate for the privilege of borrowing money. A 10-year G-Sec yielding 6.9% and a 10-year AA corporate bond yielding 8.4% means the credit spread is 150 basis points. That 150bps is the market’s current price for the default risk, liquidity risk, and other risks of that specific issuer compared to the government.
so higher credit spread means riskier issuer. got it. but what is a normal vs wide vs tight spread
In the current Indian market, rough benchmarks: AAA corporate spreads over G-Secs are around 50 to 100bps depending on tenure. AA spreads are around 130 to 200bps. A spreads are 250 to 400bps. These are not fixed, they shift with market conditions. When credit spreads widen across the board, it usually signals stress or risk aversion in the market. When they compress, it signals confidence. Tracking whether spreads are wide or tight relative to history helps you judge whether you are being adequately compensated for the risk.
so if I see a AA bond at 200bps over G-Sec that’s normal. but if I see a AAA bond at 200bps that’s actually an opportunity since AAA usually trades tighter
The practical use before buying: look up the current G-Sec yield for your target maturity. Calculate the spread on the bond you are considering. Compare that spread to typical spreads for that rating tier. If it is materially wider than usual, understand why before attributing it to opportunity. If it is in line with or tighter than typical, you are getting market-standard compensation for the risk, which is fine, but not exceptional.
This is the piece that was missing from my framework. Absolute yield tells me return. Credit spread tells me whether that return is fair compensation for the risk relative to the market. Both together give a more complete picture than either alone. Disc: going to build a simple spreadsheet to track this for bonds I am evaluating.