Credit spread

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.

The spread decomposes into the probability of default multiplied by the loss given default, plus a liquidity premium and a risk premium on top. Decomposing it is the core skill in credit analysis, because it tells you what the market thinks the default probability is and lets you disagree with a number rather than with a rating.

Spreads widen violently in stress, and they widen most for the borrowers who most need to refinance.

Decomposing it is the core skill in credit analysis. The spread is roughly the probability of default multiplied by the loss given default, plus a liquidity premium and a risk premium on top. Working out what default probability the market is pricing lets you disagree with a number rather than with a rating.