Default risk and credit spreads

You can calculate a credit spread, explain what it pays for, and describe how spreads behave when markets get nervous.

The extra yield

A company bond pays 4.7%. A government bond with the same maturity pays 3.2%. The extra 1.5 points look like free money for anyone willing to lend to the company.

They are not free. They are the market's price for a risk that government bonds in their own currency rarely carry: that the borrower does not pay. This lesson explains how that price is measured and how quickly it can change.

Spread = extra yield

The credit spread is the yield of a bond minus the yield of a government bond with the same maturity, in the same currency. It is quoted in percentage points or basis points, where 100 basis points are one point.

The spread pays investors for several things:

Default risk. A default happens when a borrower misses a payment or cannot repay. The higher the chance, the wider the spread.
Loss in a default. Investors rarely lose everything. The recovery rate is the share they get back, which depends on the company's assets and how senior the bond is.
Liquidity. Corporate bonds trade less than government bonds, and investors want a little extra for that.

Spreads differ by rating. High-yield bonds have much wider spreads than investment grade bonds. S&P's research shows why: in its 2025 European study, there had been no investment grade corporate defaults since 2009, while the speculative-grade default rate was 4.0%.

Spreads also move with the mood of the market. When investors fear a recession, expected defaults rise and spreads widen, often quickly. A wider spread means a higher yield, and that means a lower price for existing bonds, just as with rising interest rates. Corporate bonds then tend to fall at the same time as stocks, which is when diversification is needed most.

Spread 1.5 → 3.0

A fictional five-year BBB corporate bond yields 4.7%. The five-year government bond yields 3.2%. The spread is 1.5 points.

A recession scare hits. Government yields barely move, but the corporate bond's spread widens to 3.0 points.
Its yield rises to about 6.2%.
With a duration of about 4, a rise of 1.5 points in yield means a price drop of about 6%.

The company did not miss a single payment. The market simply demanded a higher price for the same risk.

Common mistakes

Treating the spread as free extra income. It pays for real risk.
Comparing yields of different maturities. A spread compares bonds of the same maturity.
Expecting corporate bonds to protect in a crisis. Spreads often widen when stocks fall.
Assuming default means zero. Recovery rates vary, and seniority matters.

The takeaway

The credit spread is the extra yield over government bonds. It pays for the risk of default and widens fast when markets fear a downturn.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the curve of the bonds that carry more credit risk.

Tap the chart.

The BBB curve lies above the government curve. The gap, about 1.5 to 1.6 points, is the credit spread.
2A 5-year corporate bond yields 6.2%, a 5-year government bond 3.7%. What is the credit spread?

Spread = corporate yield − government yield of the same maturity: 6.2 − 3.7 = 2.5 points.
3What usually happens to credit spreads when investors fear a recession?

Expected defaults rise and investors demand more for credit risk. Wider spreads mean falling corporate bond prices.
4What is the recovery rate?

Default rarely means losing everything. What investors recover depends on the company's assets and the bond's rank.

of 4 correct.