Credit spread.

In plain English

A credit spread is the yield difference between a risky bond and a Treasury of the same maturity, which is the market's price for that borrower's default risk. Spreads are quoted in basis points, where 100 basis points equals one percentage point. They widen when investors grow worried about defaults or want more compensation for illiquidity, and they narrow when confidence returns. Because spreads widen in exactly the periods when stocks fall, corporate bonds provide less protection in a downturn than Treasuries do. The same term is used for something different in options trading, where a credit spread is a position opened for a net premium received.

01Why it matters

A bond fund holding lower-rated debt can fall alongside the stock market rather than cushioning it, because spread widening and equity declines usually arrive together.

02The math, step by step

Say a ten year Treasury yields 4 percent and a ten year corporate bond of the same maturity yields 5.5 percent. The credit spread is 1.5 percentage points, or 150 basis points. On 100,000 that is 1,500 a year of extra income for accepting the chance the company does not pay.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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