Credit spread

A corporate bond yields more than a government bond of the same maturity, and the gap is the credit spread. It compensates the lender for the chance of not being repaid in full, and for the fact that the bond is harder to sell in a hurry. It is quoted in basis points, over a government yield for a fixed rate bond or over a reference rate such as Euribor for a floating rate loan.

The all in cost of borrowing is the benchmark plus the spread, and the two components have different drivers. The benchmark reflects monetary policy and the expected path of rates; the spread reflects credit risk and risk appetite. They can move in opposite directions, so a company's cost of debt can rise in a falling rate environment, which is the point most candidates miss.

Most of the movement in any single issuer's spread is not about that issuer. Spreads move together across a market because they are a price for risk appetite generally, which is why a company whose results have not changed can find its bonds ten or twenty per cent cheaper to buy after a shock somewhere else entirely.

Spreads are also the most useful early indicator in the whole macro toolkit, because credit investors are paid to worry about downside and equity investors are paid to look for upside. Credit therefore tends to reprice risk first, and a widening in spreads while equity markets hold up is the clearest warning that leveraged financing is about to get harder.