Yield Spread

  

Categories: Bonds, Investing, Econ

The yield spread helps investors make decisions. It's the difference between two yields on different debt instruments. Basically, it’s the investor saying, “what’s the opportunity cost of x security over y security? Which will get me a higher yield?”

The debt instruments don’t even have to be that similar. Apples and oranges. Bananas and kiwis. They can have different maturities, credit ratings, and levels of risk.

When looking at a yield spread, it can also help investors choose between debt instruments based on the current versus the historical yield spread. For instance, if something used to have a small return, but now has a large return, it will shrink the yield spread between that debt instrument and another, more stable security. In that case, the investor would probably go with the debt instrument that is doing very well now compared to before, since it’s attractive, with a current yield that’s higher than it was previously.

Related or Semi-related Video

Finance: What is Dividend Coverage/the D...7 Views

00:00

finance a la shmoop what is dividend coverage and what is the dividend payout

00:07

ratio? whatever.com has earnings big earnings a hundred million dollars worth

00:16

of earnings this year from sales of a whole lot of whatever's the board green [People working in a factory]

00:21

lights a dividend payment of 40 million bucks that is the company will pay 10

00:26

million dollars to its common shareholders of record four times in

00:30

this next year the payout is 40 million because well

00:35

you know it's paid out and yeah clever titling know is never a thing on Wall

00:39

Street and the payout ratio is 40 over a hundred that hundred million of earnings [Payout ratio calculation appears]

00:44

or forty percent well why does the payout ratio even matter?

00:48

well companies hate having to cut their dividends and they love raising them if

00:52

the former well stock prices usually crash if the latter well they usually go

00:57

up and companies love it when their stock prices go up duh so what would [Whatever.com share price rises]

01:02

happen if whatever dot-com stumbled in its earnings tumbled and then

01:05

shareholders mumbled that the earnings payout ratio had crumbled that is... okay

01:10

stop with the rhyming bad timing okay now we're stopping and yeah that is what

01:15

if the earnings of whatever.com went down next year to only 50 million

01:18

remember they were a hundred million now they're only 50....hmm

01:21

problem because now the payout ratio is 80 percent 40 over 50 yeah very

01:27

difficult situation the company thought it would have tons of earnings to cover

01:31

its dividend at the forty million dollar level more or less forever

01:35

but clearly it did not so now what well if earnings recover and go back to a [Man discussing whatever.com's earnings]

01:41

hundred million dollars on their way to the 300 million they projected well,

01:45

then life is grand no sweat no heavy decisions to be made

01:48

but what if earnings fall further to be only thirty million the following year

01:53

well then whatever dot-com has to either borrow money or deplete its cash

01:57

reserves just to cover its dividend in which case the payout ratio would then

02:03

be over a hundred percent meaning that the earnings were 30 million and the [Earnings appear]

02:07

dividend was to be forty well then the payout ratio would be 40 over 30

02:12

133% ouch can't do that for very long without going bankrupt so payout ratios [Wheel spins and lands on bankrupt]

02:17

matter because they give a sense for the safety or certainty that that dividend

02:22

will continue at its present rate if the ratio is low well odds are good the

02:27

company could certainly afford to raise the dividend over time or at least not

02:30

cut it yeah for a very long time ideally and if the ratio is high well your [Dividend cut with scissors]

02:35

bottom line may soon be bottoming out back-end load there if i ever saw it...

Up Next

Finance: What is Spread To Treasuries?
3 Views

Spread to treasuries is an indication of risk associated with a given debt or bond offering.

Finance: What is an Accumulated Dividend?
9 Views

What is an Accumulated Dividend? Accumulated dividends are dividends paid on cumulative preferred stock. They are referred to as accumulated becaus...

Finance: What is Dividend Yield?
4 Views

What is Dividend Yield? Similarly to how a bond’s price and coupon is calculated to determine yield, dividend paying stocks also have a yield asc...

Find other enlightening terms in Shmoop Finance Genius Bar(f)