Introduction to Credit spreads

Document Sample
Introduction to Credit spreads Powered By Docstoc

In finance, credit spreads are indicated with a number of measures that are used to
determine how much an investor is paid to be compensated for taking credit risk
inherent in the title. Among the well-known measures are credit yield spread, asset
swap spreads, option adjusted spread (OAS), zero-volatility spread, discount margins,
default swap spreads, hazard rate.

The interest spread is rather the differential between the interest rate on debt
instruments issued by the debtor country and a benchmark interest rate, consisting of
the performance bonds issued by the creditor country, with the same denomination and
the same maturity.

Composition theory

It represents the sum of:

     * An estimate of the expected risk of default by the borrower during the term of the
     * And a liquidity premium, that is to say an estimated cost of negotiation of the

Credit spreads are experiencing significant and rapid changes, both in regard to a
particular issuer a class of issuers. Taken together, they depend:

   * Supply and aggregate demand for capital;
   * The demand for capital by the states, first borrowers (over 50%) in the bond

Developed countries, with a generally stable economic and financial system and said,
enjoy a better credit standing of developing countries and, in general, a lower risk
country, this makes it less risky investments in securities of these countries and a lower
interest rate. Conversely, the same logic, the interest rates on emerging market debt are
higher and involve a higher cost of debt.

One of the most widely used measures for the interest spread is the spread on Brady
Bonds. In the '90s, the market for these securities has been much more active than
other types of bond markets in emerging countries, suggesting their greater reliability in
the indication of the value of underlying assets, the data relating to spreads on Brady
bonds are available with a high frequency of detection.

Subsequently, the passage of the emerging countries to various sources of funding
such as bank loans and, above all, new bond issues, has overshadowed the Brady
bonds, new debt was generally unsecured (unlike Brady bonds that were partially
guaranteed) and with shorter maturities, qualities that have ensured lower spreads and
lower funding costs more.
For this reason, the spreads on Brady bonds may not be representative of the cost of
financing and emerging needs new measurement techniques. Two possible alternatives
are formed by the Eurobond spreads of emerging markets and the EMBI + (Emerging
Markets Bond Index), an index of yields on emerging market bonds, including
Eurobonds and Brady bonds.

Shared By: