Yield spread is defined as the difference in yield between a credit-risky bond and a credit-risk-free bond of similar maturity.

• A. Difference in price between the bonds
• B. Difference in yields between the bonds
• C. Difference in coupon rates
• D. Difference in maturity dates

Answer: (B)

Yield spread represents the extra return investors require for taking on credit risk, relative to a risk-free bond of the same maturity. Because the two bonds have similar maturities, comparing their yields cleanly isolates the credit risk premium embedded in the risky bond. Therefore the difference in yields is the measure of the yield spread. For example, if a corporate bond yields 6% and a Treasury of similar maturity yields 4.5%, the yield spread is 1.5 percentage points (150 basis points). Differences in price, coupon rates, or maturity dates don’t directly quantify the credit risk premium the spread captures.