There are two main types of securities investors can invest in. They are stocks and bonds. Stocks represent a form of ownership, however, bonds represent a form of debt to the company. In exchange for the use of funds on bonds, investors are paid a rate of interest which depends on the credit worthiness of the borrower. Treasuries are issued by the U.S. government and so they are considered to be risk-free. When analysts are trying to price other bonds they will sometimes look at the spread or the difference between treasury rates and other securities.
Determine the Spread
Obtain the latest list of treasury yields. This is also referred to as the yield curve. For every time frame associated with a treasury security, there is a corresponding interest rate. The U.S. government publishes rates on a daily basis.
Identify the asset or investment you wish to compare against treasuries. This will determine exactly which duration of treasury to calculate the spread to. For this example, and for the sake of clarity, assume you want to compute the spread for a 10-year corporate bond that pays 10 percent and a 7-year annuity that pays 8 percent.
Find the interest rate associated with treasuries which are comparable in duration. For instance, the interest rate associated with 10-year treasuries on Monday, May 23, 2011 was 0.84 percent. The interest associated with 7-year treasury was 0.38.
Calculate the spread to treasuries. The spread for the 10-year corporate bond is calculated by subtracting .84 from 10. The answer is 9.16 percent. The spread for the 7-year annuity is calculated by subtracting 0.38 from 8 percent, or 7.62 percent.
