Hong Life CalculatorsUnderstanding the credit spread calculator — concept and principle
This calculator finds the credit spread between a corporate bond and a government bond of the same maturity, in percentage points and basis points. It also shows the extra yearly income on your amount, the default rate the market would be pricing in for a given loss given default, and the yield ratio. Use it to compare bonds, track credit conditions and understand what investors are paid for credit risk.
How it is calculated
- Credit spread = corporate yield − government yield (same maturity and currency).
- Basis points = percentage points × 100.
- Extra yield per year = amount × spread.
- Default rate priced in ≈ spread ÷ loss given default (LGD).
- Yield ratio = corporate yield ÷ government yield.
The principle
A government bond in its own currency is treated as close to default-free, so the extra yield on a corporate bond of the same maturity pays for the chance of default, lower liquidity and uncertainty. A rough rule, sometimes called the credit triangle, says spread ≈ probability of default × loss given default. Dividing the spread by LGD therefore gives the yearly default rate implied if the whole spread were expected loss. Because part of the spread is a premium for risk and liquidity, this overstates the real expected default rate.
Worked example
Default inputs: corporate yield 5.6%, government yield 4.2%, LGD 40%, amount $10,000.
- Spread = 5.6 − 4.2 = 1.4 percentage points = 140 bp.
- Extra yield on $10,000 = 10,000 × 1.4% = $140.00 a year.
- Default rate priced in = 1.4% ÷ 40% = 3.5% a year.
- Yield ratio = 5.6 ÷ 4.2 ≈ 1.33.
| Yield of the corporate bond (%) | Credit spread (basis points) |
|---|---|
| 1.4 | -280 |
| 2.8 | -140 |
| 4.2 | 0 |
| 5.6 | 140 |
| 7 | 280 |
| 8.4 | 420 |
| 11.2 | 700 |
How to read the result
Wider spreads mean investors demand more compensation, because of higher perceived credit risk or poorer market conditions. Compare spreads only between bonds of similar maturity, currency and seniority. The implied default rate is an upper bound, useful for comparing bonds, not a forecast of defaults.
Common mistakes
- Comparing yields of bonds with different maturities.
- Treating the implied default rate as an actual default probability.
- Mixing currencies, which adds currency effects to the spread.
- Ignoring call features that raise a bond's yield for reasons other than credit.
Frequently asked questions
What is a good credit spread?
There is no fixed value; compare with bonds of similar rating and maturity and with the spread's own history.
What does 100 basis points mean?
One percentage point of yield.
What LGD should I use?
Banking rules use 40% as a supervisory LGD for senior unsecured corporate claims in the foundation IRB approach; actual recoveries vary.
Sources: Basel Committee on Banking Supervision, Basel Framework CRE32.7 (supervisory LGD for senior unsecured corporate claims) · Credit spread and spread ≈ PD × LGD (standard fixed-income definitions)