## Saturday, November 05, 2011

### Types of Yield Measures

CFA Level 1 - Fixed Income Investments

Even though the way most investors discuss spreads is based on a Treasury security with the same maturity as the one it is being compared to, an investor can also talk about spreads between any two bonds with the following measures:
This is the way most spreads are measured in the market. This spread measures the difference in spread between two bonds in terms of basis points.

The equation is: Yield Spread = Yield on Bond A - Yield on Bond B

This ratio measures the yield spread relative to the reference bond.

This equation is:
Relative Yield Spread =Yield on bond A- Yield on Bond B/ Yield on Bond B

3.Yield Ratio
This is just the ratio of the yields between the two bonds.

The equation is: Yield on Bond A / Yield on Bond B

Market convention is to use the on-the-run government security as the reference yield or bond. So in the above equations, one would replace Bond B with the comparable government security.

Example: Yield Ratios
We want to compare an IBM five-year bond with a yield of 4.5 % and the on- the-run government five-year with a yield of 3.75%

Absolute Yield Spread = 4.5% - 3.75% = .75% or 75 basis points

Relative Yield Spread = 4.5%- 3.75% / 3.75% = .20 = 20%

Yield Ratio = 4.5% / 3.75% = 1.20

Investors may find relative spreads a better measure because they measure the magnitude of the yield spread and the way it is affected by interest-rate levels. While absolute spread may be maintained as rates change, relative spreads will move in or out depending on the level of rates.

Example:
Use the IBM and Treasury bond from the previous example, except now assume that yields have increased.

Absolute Yield Spread 5.75%- 5.00% = .75% or 75 basis points. Even though yields have increased the spread is the same. However, the Relative Spread has changed too: 