Credit spread (bond)

The credit spread is a surcharge return, get the investors with an investment in failure -risk bonds. The credit spread compensates the investor for the risks associated with the investment. The credit spread is measured in basis points. The worse is the capital market rating of a bond, the higher the credit spread.

• 2.1 economy
• 2.2 yield curve
• 2.3 Stock Market
• 2.4 liquidity

Risk premium

The credit spread represents a risk premium for the acquired the investment credit, spread and liquidity risks

Credit risk

The credit risk associated with the credit quality of the issuer. Rating agencies such as Standard & Poor's ( S & P), Moody's or Fitch Ratings downgrade the credit rating of issuers on a standardized one. The result of the assessment of their future ability to repay debt is the credit rating. Lower rating classes in this case have a lower credit rating and therefore a higher probability of default, which is reflected in higher credit spreads. Assuming that issuers same ratings of comparable credit quality, as the credit spreads will move in similar orders of magnitude. Since the rating does not necessarily at all times is a current credit rating ( " stickiness " ), it might be bigger spread differences within each rating category.

Credit risk can be divided into the migration and default risk. Under the migration risk is the risk that the credit quality of the issuer deteriorates, and therefore decreases the market price of a corporate bond. The bond investor suffers in this case an asset loss equal to the price change. Migration risk is often operationalized through a change to a different rating category.

The risk of default is a special case of immigration risk represents the bond migrated to the worst rating class, the default class. The bond fails and the investor receives the principal and interest payments outstanding only one share.

Spread risk

Even with constant credit quality of an issuer, the credit spread fluctuates over time. If the credit spreads rise because of increasing risk aversion of capital market actors, fall, ceteris paribus, the prices of corporate bonds. Investors suffer a loss of wealth. Spread risk is striking, especially in the capital market crises, as was observed for example during the LTCM crisis in 1998 or during the subprime crisis since 2007.

Liquidity risk

Liquidity expresses the tradability of bonds. A bond investor is affected by liquidity risk if it can not sell at a given market price, but only at a discount an item. The price of liquid bonds is higher than that of illiquid bonds. Therefore, illiquid bonds have a higher yield and thus a higher credit spread.

Factors

A number of macroeconomic variables contribute to the explanation of the credit spread over time. In the context of empirical capital market research variables of the economy, the interest rate structure of the stock market and liquidity are used to explain.

Economy

In periods of economic downturn, the future prospects of the company deteriorate. The orders are declining and thus reduces the cash flow that is available to service the debt liabilities available. This increases the credit risk and therefore increases the credit spread. Therefore, there is between the economic variables such as overall economic growth or gross domestic product is a connection.

Yield curve

The influence of the yield curve on the credit spreads resulting from the cyclical nature of the market interest rates. In a downturn, when central banks pursue a more expansionary monetary policy, interest rates fall, as they rise in the upswing in a shortage of capital offer. Therefore, there is a negative correlation between credit spreads and interest rates.

The default risk of a corporate bond can be assessed using the Structural Models. These option pricing theory approaches the risk of default is considered a put option. The value of the put option decreases when the market interest rate increases. Can be expected over the theoretical valuation model, therefore, a negative correlation between credit spreads and interest rates.

Stock market

The stock price of a company expresses the expectations of market participants about the future prospects of the company. Therefore, the credit risk decreases with rising share prices. This relationship can also be found with the help of the Structural Models.

Liquidity

Liquidity affects the value of a corporate bond. Therefore, the credit spread increases as the liquidity of the bond reduced.

Risk-free reference

The credit spread is determined as the difference in yield between a corporate bond and a default-risk -free benchmark. The Reference Obligation must satisfy three conditions:

• They must be free of default risk.
• You must map the entire maturity spectrum.
• You must be actively traded on a liquid market.

Government bonds, swaps and mortgage bonds meet these criteria. Bonds issued by countries with top credit ratings are considered to be default risk-free. These include Germany ( Bunds ) or the United States ( U.S. Treasuries).

While capital market practitioners determine the credit spread as the yield differential on swaps, the scientific literature is generally assumed that government bonds are to be used as a reference.

The credit spread is determined on the basis of returns. To this end, the difference between spot rates of corporate and government bonds is calculated. Capital market practitioners use often yields with the same maturity bonds. However, as certain credit spread of market interest rates on the date of calculation depends.

CDS spreads are the prices of credit default swaps represents a credit default swap is an instrument used to hedge the risk of default. Credit spreads and CDS spreads differ in their height. If one uses government bonds as risk- free reference in the credit spread calculation so regularly exceed credit spreads, CDS spreads. While credit spreads have to be calculated, are CDS spreads on stock market information systems for numerous issuers and different maturities available.