In finance, I know the term ‘spread’ can mean a few different things depending on the context, but I’m a bit confused about all its uses. Could someone clarify what ‘spread’ typically refers to? For example, I’ve heard it in relation to the difference between bid and ask prices of securities, but I’m also aware that it’s used in terms of credit spreads and yield spreads. I’m specifically interested in understanding the different types of spreads and how they are applied in financial analysis or trading.
What does the term ‘spread’ refer to in the field of finance?
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7 months ago
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7 months ago
In finance, ‘spread’ indeed has several meanings. The one you mentioned, the difference between bid and ask prices, is known as the bid-ask spread. This is the gap where transactions occur and reflects the immediate cost of trading that instrument. A narrow spread usually indicates a highly liquid market, while a wider spread can signify less liquidity.
Another type is the yield spread which is the difference between the yield on different debts. For instance, the yield on a corporate bond versus a government bond of the same maturity. Investors use this to assess the extra return demanded for taking on more risk. The yield spread can indicate the health of economic sectors or markets.
Lastly, the credit spread relates to the difference in yield between bonds with differing credit qualities but similar maturities. It reflects the risk premium for investing in debt with a higher chance of default. Credit spreads widen when lenders demand higher yields for higher risk and tighten when the market appetite for risk is stronger. Have you considered how spreads might reflect economic conditions or influence your investment decisions?
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