Bond Yields, Treasury Rates, and Credit Spreads

Summary

The document asks whether a bond’s required return is simply the base interest rate or also reflects issuer creditworthiness. It distinguishes the yield used to discount a bond’s coupon and principal payments from the idea of a benchmark rate, then presents the answer that, in the United States, corporate bond yields are commonly viewed as a comparable-maturity US Treasury yield plus a credit spread.

The spread compensates for differences in issuer credit quality: stronger issuers may have smaller spreads, while weaker issuers may require larger ones. The response gives illustrative spread figures but does not explain how to estimate spreads, account for liquidity or tax effects, or distinguish yield to maturity from realized return. Its statement is a simplified description of bond pricing, not a complete decomposition of every bond’s required return.

Key ideas

• A bond’s yield need not equal the base interest rate.
• US bond yields are commonly described as a comparable-maturity Treasury yield plus a credit spread.
• The spread reflects issuer creditworthiness and tends to be larger for lower-quality issuers.
• This decomposition is simplified and does not cover other factors that can affect yields or realized returns.

Tags

# Is return required by a bond investor a function of base interest rate and credit worthiness of the issuer?


# Is return required by a bond investor a function of base interest rate and credit worthiness of the issuer?












The price of a non-zero coupon bond (with dicrete discounting) is found using $$B = \frac{C}{r}\Bigg(1-\frac{1}{(1+r)^n}\Bigg) + \frac{P}{(1+r)^{n}}$$ or for a continuously dicounted version: $$B = C\cdot e^{-r}\Bigg(\frac{1-e^{-r \cdot n}}{1-e^{-r}}\Bigg) + P\cdot e^{-r \cdot n}$$ where $C$ -- coupon payment, $P$ -- face value, $n$ -- number of compounding periods.

Now $r$ depending on the context is called yield to maturity, the return required by investor or base interest rate.

It seems that often an implicit suggestion is made that: $$return \; required \; by \; investor \; = base \; interest \; rate$$

My question is as follows: is above equality true or is yield (or return required by investor) more like $$r (i, c)$$ a function of base interest rate $i$ and credit worthiness $c$?

## Answer by dm63 (score 1)

https://quant.stackexchange.com/a/36576

Yes, in the US, the yield on a bond equals the yield on a US Treasury bond with a similar maturity plus a credit spread reflecting the creditworthiness of the issuer. If the issuer is high quality the spread might be a low number (say 0.50%), and if the issuer is low quality it could be much higher say 2%).

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.