Daily Economics, Business & Finance Study
October 19, 2026 (KST) · Day 29
Today’s Topic: What Is Added to a Government Yield to Price a Corporate Bond? — Reading Credit Spreads, Ratings, and Default Risk
1. Review of the Previous Lesson
Day 28 explained that a bond’s price is the present value of its future coupons and principal and used duration and convexity to show why price falls when the market yield rises. Today, we will split that market yield into a government-bond yield and a credit spread and examine why a corporate bond with the same maturity pays more than a government bond.
2. Today’s Core Concept
A corporate bond yield can be simplified as the yield on a government bond in the same currency with a similar maturity plus a credit spread.
\[ Corporate\ bond\ yield \approx Benchmark\ government\ yield +Credit\ spread \]
In a narrow sense, the credit spread compensates for the possibility of default. In actual markets, it also reflects expected credit loss, downgrade risk, liquidity, risk aversion, supply and demand, and embedded options.
Today’s learning objectives are to:
- Decompose a corporate bond yield into a benchmark yield and a credit spread.
- Calculate a spread in basis points and interpret why it changes.
- Distinguish a credit rating from a market spread.
- Understand expected credit loss intuitively through probability of default, loss given default, and recovery rate.
- Connect changes in corporate bond yields to refinancing cost, FCF, and equity value.
3. Concept Explanation
3-1. The Benchmark Government Yield Prices Time; the Spread Prices Additional Risk
The yield on a government bond in the same currency is commonly used as a benchmark for a corporate bond. A corporate bond investor lends to a company instead of the government, assumes additional risks, and therefore demands a higher yield.
\[ Credit\ spread =Corporate\ bond\ yield-Benchmark\ government\ yield \]
If a five-year corporate bond yields 4.60% and a comparable five-year government bond yields 3.20%, the spread is 1.40 percentage points, or 140 basis points.
- 1 bp = 0.01 percentage point = 0.0001
- 100 bps = 1.00 percentage point
- Spread widening: the relative risk price of the corporate bond rises
- Spread tightening: the relative risk price of the corporate bond falls
Actual markets may use one government bond with the same maturity, a government spot curve, or a swap curve as the benchmark. Comparisons must align the currency, maturity, benchmark curve, and yield definition.
3-2. A Credit Spread Reflects More Than Probability of Default
A corporate bond spread can be understood as a package of compensation for the following risks.
| Component | Meaning | Typical Cause of Widening |
|---|---|---|
| Expected credit loss | Probability of default and the amount not recovered after default | Weaker earnings, higher leverage |
| Rating and migration risk | Possibility of a downgrade or loss of investment-grade status | Negative outlook, weaker financial policy |
| Liquidity premium | Risk of being unable to trade quickly at a desired price | Less trading, market shock |
| Risk premium | Compensation for bearing uncertainty | Higher volatility, stronger risk aversion |
| Supply-and-demand and technical factors | New issuance, fund redemptions, regulation, and index eligibility | Heavy issuance, forced selling |
| Option effect | Possibility that early redemption changes cash flows | Change in call likelihood, higher volatility |
A spread of 200 bps therefore does not mean that the market expects an exact annual default loss of 2%. A spread is a market price that combines several types of risk compensation.
3-3. Expected Loss Starts with Probability of Default Times Loss Given Default
The simplest intuition for credit risk is:
\[ Expected\ loss\ rate \approx Probability\ of\ default\ (PD)\times Loss\ given\ default\ (LGD) \]
\[ Loss\ given\ default\ (LGD) =1-Recovery\ rate \]
- PD·Probability of Default: the probability that default occurs within a defined period
- LGD·Loss Given Default: the share of principal lost if default occurs
- Recovery rate: the share recovered through collateral disposal, restructuring, or liquidation after default
This formula is a simplified expected value. Actual bond pricing also reflects default timing, lost coupons, seniority, collateral, legal proceedings, liquidity, risk premiums, and discount rates.
3-4. A Credit Rating Is a Relative Risk Opinion, Not a Yield Table
A credit rating agency expresses an opinion about an issuer’s or a specific obligation’s ability to pay interest and principal using letter grades. On S&P Global Ratings’ scale, BBB- and above are investment grade, while BB+ and below are speculative grade. Other agencies, including Moody’s, use different symbols, so grades should not be compared by matching letters mechanically.
When reading a rating, distinguish among:
- Issuer rating and issue-specific rating
- Long-term and short-term ratings
- Senior and subordinated claims, and secured and unsecured debt
- The rating itself and the outlook—positive, stable, or negative
- Outlook and CreditWatch or a similar review status
- Domestic-scale and global-scale ratings
Two bonds rated BBB can have different spreads because their maturities, seniority, collateral, industries, liquidity, or rating agencies differ. A market spread can also move before an agency changes the rating.
The U.S. SEC’s investor guidance describes ratings as estimates of relative credit risk and warns that even a top rating does not guarantee repayment. A rating is therefore the start of analysis, not its conclusion.
3-5. Crossing the Investment-Grade Boundary Can Change Market Demand Sharply
Some funds, indices, and internal policies permit only investment-grade holdings. When an investment-grade corporate bond is downgraded to speculative grade, it becomes a fallen angel and can face mechanical selling and weaker liquidity. A rising star moving from speculative grade to investment grade can gain access to a broader investor base.
Do not forecast price from one rating notch alone. If the market has already priced in a downgrade, the spread may stabilize after the formal announcement. A spread can also widen while the rating remains unchanged if earnings and cash flow deteriorate.
3-6. Government Yields and Credit Spreads Can Move in Opposite Directions
The change in a corporate bond’s total yield can be decomposed as:
\[ \Delta Corporate\ bond\ yield \approx\Delta Government\ yield +\Delta Credit\ spread \]
When recession fears rise, safe-haven demand and expectations of easier monetary policy may lower government yields, while concerns about corporate defaults and liquidity widen credit spreads by an even larger amount. A fall in government yields therefore does not mean that every corporate bond will rise in price.
Connecting this to Day 28’s duration:
\[ \frac{\Delta P}{P} \approx-D_{mod}\times (\Delta Government\ yield+\Delta Credit\ spread) \]
Corporate bond analysis should consider not only interest-rate duration but also spread duration, which measures sensitivity to a change in the credit spread.
3-7. A Nominal Spread and OAS Are Not the Same Measure
A simple credit spread can be calculated by subtracting a government yield at a specific maturity from a corporate bond’s yield to maturity. However, bonds differ in coupon and cash-flow timing and may include rights such as call options that alter the cash flows.
Option-adjusted spread (OAS) seeks to adjust for the yield curve and embedded options. It can be close to a simple spread for a plain corporate bond without an option, but the difference can be large for a callable bond. Spreads with different definitions should not be compared in one table as though they were identical.
3-8. A Higher Yield Does Not Necessarily Mean a Higher Realized Return
A high-yield bond may offer more coupon and interest income, but the following losses can also be greater:
- Default and missed interest or principal payments
- Price loss after a downgrade
- Poor liquidity and a wide bid–ask spread
- Early redemption that removes a high coupon
- Simultaneous losses across many bonds during a recession
Yield to maturity is a calculated return that assumes all promised cash flows are received and reinvested at the same yield. Actual realized return changes if a default or early redemption occurs.
4. A Simple Numerical Example
All figures below are hypothetical educational examples. They do not represent an actual bond, company, market forecast, or investment recommendation. Taxes and transaction costs are excluded.
① Calculate the Corporate Bond Yield and Credit Spread
Assume the five-year government yield is 3.20% and a Company A bond with the same maturity yields 4.60%.
\[ Credit\ spread =4.60\%-3.20\% =1.40\ percentage\ points =140\ bps \]
② Spread Widening Can More Than Offset a Decline in the Government Yield
| Item | Before | After | Change |
|---|---|---|---|
| Five-year government yield | 3.20% | 2.90% | -30bp |
| Company A credit spread | 120bp | 220bp | +100bp |
| Company A corporate bond yield | 4.40% | 5.10% | +70bp |
\[ 5.10\%-4.40\% =+0.70\%p =+70bp \]
The government yield fell, but the spread widened by more, so the corporate bond yield rose.
If modified duration is 4.3, the first-order approximation of the price change is:
\[ \frac{\Delta P}{P} \approx-4.3\times0.007 =-3.01\% \]
If market value was KRW 5 billion, the estimated valuation loss is approximately KRW 150.5 million.
\[ KRW\ 5\ billion\times3.01\% =KRW\ 150.5\ million \]
③ Calculate Simplified Expected Credit Loss
Assume the one-year probability of default is 2% and the recovery rate after default is 40%.
\[ LGD=1-40\%=60\% \]
\[ Expected\ loss\ rate \approx2\%\times60\% =1.2\% \]
The simplified expected loss on KRW 10 billion of principal is KRW 120 million. Actual accounting expected credit loss and the market spread can differ because of scenarios, horizon, discounting, collateral, liquidity, and risk premiums.
5. How to Use This in Stock and Company Analysis
① Split a Company’s New Borrowing Cost into the Benchmark and the Spread
When a corporate bond yield rises, ask two questions first.
- Did government yields rise and lift the benchmark for all borrowers?
- Did this company’s spread widen because its company-specific credit risk increased?
If the government yield caused the move, discount rates and funding costs may be rising across the industry. If only the company spread widened, first review earnings, leverage, M&A, shareholder distributions, litigation, regulation, and liquidity.
② Connect Refinancing Cost to FCF and Interest-Coverage Capacity
Calculate in the following order:
- Bonds and borrowings maturing in the next one to three years
- Existing average interest rate versus the current new borrowing rate
- Additional annual interest expense
- Whether operating profit, EBITDA, OCF, and FCF can cover it
- Additional effects of covenants and a rating downgrade
A temporary spread widening may have limited near-term earnings impact if no maturity is near and liquidity is ample. A company with concentrated maturities can suffer a large decline in FCF and shareholder value even from a small rise in its spread.
③ Watch for Signals from Corporate Bonds Before Equities
If a company’s share price is stable while its bond spread widens faster than peers, investigate whether the bond market is pricing cash-flow, collateral, or refinancing risk earlier. However, a few trades can distort the price of an illiquid bond, so review trading volume and several maturities together.
④ Look at the Direction of Financial Metrics, Not Only the Rating
Check whether the following changes are occurring together:
- Higher net debt to EBITDA
- Lower interest coverage
- Weaker OCF and FCF
- A larger short-term borrowing share and more concentrated maturities
- More collateral and tighter covenants
- Weaker creditor protection after a large acquisition, dividend, or share repurchase
A rating can be a lagging summary of risk within a broad band. Read changes in cash flow and financial policy first.
⑤ Match the Terms Even When Two Bonds Have the Same Rating
Match currency, remaining maturity, seniority, collateral, coupon, options, issue size, trading frequency, and industry. Directly comparing the spreads on a three-year senior unsecured bond and a ten-year subordinated callable bond can lead to a false conclusion.
⑥ Extend the Analysis to Equity Value with Stress Tests
Move the benchmark government yield and the credit spread separately.
| Scenario | Government Yield | Credit Spread | First Item to Check in the Company and Equity |
|---|---|---|---|
| Soft landing | Gradual decline | Stable or tighter | Lower refinancing cost and better valuation |
| Reacceleration of inflation | Rise | Modest widening | Higher interest expense and WACC |
| Recession | Decline | Sharp widening | Revenue, margins, default risk, and low-quality bond losses |
| Company-specific shock | Stable market | Widening only for the company | Liquidity, covenants, and ability to issue equity or sell assets |
Do not view a highly leveraged company favorably merely because government yields fell. Review its actual corporate spread and refinancing access as well.
6. What to Find in Disclosures
Market Data: Check Outside Company Filings
The following are official or primary-source locations checked as of October 19, 2026 (KST). Today’s lesson does not use an actual index value; confirm the observation date and units when retrieving data.
| Data | Where to Check | What to Check |
|---|---|---|
| Basic structure and risks of U.S. corporate bonds | SEC Investor.gov — Corporate Bonds | Default risk, covenants, ratings, and liquidity |
| Meaning and limits of credit ratings | SEC Investor.gov — The ABCs of Credit Ratings | Ratings are relative risk estimates, not guarantees |
| Rating scale | S&P Global Ratings — Understanding Credit Ratings | Investment-grade boundary and rating definitions |
| U.S. investment-grade OAS | FRED — ICE BofA US Corporate Index OAS | Observation date, units, and index and OAS definitions |
| U.S. high-yield OAS | FRED — ICE BofA US High Yield Index OAS | Level and change versus investment grade |
| Individual U.S. bond trades | FINRA Fixed Income Data | TRACE price, yield, trade size, and time |
| Korean government and corporate bond yields | Bank of Korea ECOS·KOFIA Bond Information Center | Yields by rating and maturity, observation date, and trade data |
Check the difference between OAS and a simple yield-to-maturity spread, index composition, average duration, and observation frequency. Do not calculate a spread by subtracting government and corporate yields from different dates.
Korean Companies: DART
Korea’s DART provides annual, semiannual, and quarterly reports and securities registration statements. Find:
| Disclosure Location | What to Check |
|---|---|
| Borrowings and bonds note | Balance by type, coupon and effective interest rates, maturity, collateral, and repayment terms |
| Liquidity-risk note | Contractual cash outflows and maturities concentrated within one year |
| Credit-risk note | Exposure by rating, delinquency, collateral, and expected credit losses |
| Finance income and cost | Actual interest expense and gain or loss on bond retirement |
| Contingencies and commitments | Financial covenants, guarantees, and events of default |
| Funding record and registration statement | Issue yield, maturity, rating, use of proceeds, and underwriting terms |
| Credit-rating information | Rating agency, grade, rating date, and reason for a rating change |
| Going concern and auditor’s report | Liquidity uncertainty and refinancing-related emphasis |
Templates and labels vary by company, so searching the document for bonds, borrowings, credit rating, financial covenants, event of default, liquidity risk is practical. The coupon at issuance and the current market yield can differ.
U.S. Companies: 10-K, 10-Q, and Offering Documents
SEC EDGAR is where you should review:
- 10-K Item 1A — Risk Factors: rating downgrade, refinancing, and covenant risks
- 10-K Item 7 / 10-Q Part I, Item 2 — MD&A: liquidity, capital raising, cash requirements, and refinancing plans
- 10-K Item 8 / 10-Q Part I, Item 1 — Financial Statements and Notes: debt, interest rates, maturities, collateral, covenants and fair value
- 10-K Item 7A / 10-Q Part I, Item 3 — Market Risk: interest-rate and spread sensitivity
- 8-K: material new borrowings, defaults, covenant amendments, and credit agreements
- Registration statement and prospectus supplement: coupon, maturity, seniority, collateral, redemption, use of proceeds, and underwriting terms
An issuer’s periodic filing may omit or lag the rating agency’s latest grade and outlook and the individual bond’s current price, OAS, and TRACE trading data. Align filing facts and external market data to the same date and identify their sources separately.
7. Key Takeaways
- A corporate bond yield can be simplified as the benchmark government yield plus a credit spread.
- A credit spread reflects expected credit loss as well as downgrade risk, liquidity, risk appetite, supply and demand, and options.
- Simplified expected loss is
probability of default × loss given default, and loss given default is1 − recovery rate. - A credit rating is an opinion about relative credit risk, not a repayment guarantee or a precise probability of default.
- A corporate bond yield can rise and its price can fall if the spread widens by more than the government yield declines.
- Interpret corporate bond price sensitivity by applying duration to both the change in government yields and the change in spreads.
- A downgrade across the investment-grade boundary can trigger forced selling and weaker liquidity, but check whether the market priced it in beforehand.
- In company analysis, connect the spread to debt maturities, refinancing rates, interest coverage, OCF, FCF, and covenants.
- Obtain current spreads and trade prices separately from official bond-market data for the same date; they are not company filing items.
8. Three Review Questions
Question 1
The seven-year government yield is 3.10%, and a Company B bond with the same maturity yields 4.85%. What is the credit spread in percentage points and basis points?
Question 2
The government yield fell 40 bps, but one company’s credit spread widened 130 bps. By how many basis points did the corporate bond yield change on net? If modified duration is 5, what is the approximate price change when convexity and transaction costs are ignored?
Question 3
Two corporate bonds are both rated BBB-, but Bond C is a three-year senior unsecured bond and Bond D is a ten-year subordinated callable bond. Can their spreads be compared directly merely because the ratings are the same? Name at least three additional terms that must be aligned.
Answers and Explanations
1
\[ 4.85\%-3.10\% =1.75\%p =175bp \]
The credit spread is 1.75 percentage points, or 175 bps.
2
\[ \Delta Corporate\ bond\ yield =-40\ bps+130\ bps =+90\ bps =+0.009 \]
\[ Price\ change \approx-5\times0.009 =-4.5\% \]
Although the government yield fell, the larger spread widening lifts the corporate bond yield by 90 bps, implying an approximate price decline of 4.5%.
3
No. At a minimum, align currency, remaining maturity, seniority, collateral, coupon, call option, issue size, trading liquidity, industry, and benchmark curve. Even for the same issuer rating, differences in an individual bond’s recovery priority and options can produce a different issue rating and spread.
Next Lesson — Day 30:
“Credit Spreads Are the Economy’s Thermometer — Reading the Credit Cycle Through IG, HY, and Default Rates”