Glossarytaught in FI1.01, E11.01
Credit spread
Also called spread over government, credit risk premium.
The extra yield a corporate bond offers over a government bond of the same maturity, compensating for default risk and for lower liquidity.
A corporate bond at 9.4% against a government bond at 7.2% carries a 220 basis point spread.
Decomposing it is the core skill in credit analysis, and it's less mysterious than it sounds. As a rough formula, the spread is the probability of default multiplied by the loss given default. Add a liquidity premium and a risk premium on top. Working out what default probability the market is pricing lets you disagree with the market's number, and not just with a rating.
Spreads widen violently in stress, and they widen most for the borrowers who most need to refinance.
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