KNOWLEDGE CHECK What does it mean when a company’s corporate spread tightens? The benchmark yield is outperforming the company’s bonds. The company’s borrowing cost increases. The company’s bonds are outperforming the benchmark yield. The company’s borrowing capacity will become more restrictive. PREV SUBMIT
The Correct Answer and Explanation is:
The correct answer is: The company’s bonds are outperforming the benchmark yield.
When a company’s corporate spread tightens, it means that the yield on the company’s bonds is getting closer to the yield on a benchmark, typically a risk-free government bond, such as U.S. Treasury bonds. The spread represents the difference in yields between the company’s bonds and government bonds of similar maturity. If the spread tightens, it indicates that the company’s bonds are becoming more attractive relative to the benchmark bonds, as the difference in yield shrinks.
This tightening of the spread is generally a positive sign for the company. It can happen when investor perception of the company’s credit risk improves, leading to increased demand for its bonds. When demand rises, the price of the bond increases and its yield decreases, resulting in a narrower spread compared to the benchmark. As the yield on the company’s bonds approaches the yield of government bonds, it suggests that the company is seen as less risky, which means investors expect lower returns to compensate for that risk.
A tightening spread reflects that the company’s borrowing cost is decreasing, as it is able to borrow at a rate closer to the risk-free rate. In essence, the company is able to raise capital at lower costs, which benefits its financial situation. The opposite of tightening would be widening, which suggests that investors perceive higher risk, and the company’s bonds would offer higher yields to compensate for that risk.
Thus, when the spread tightens, it is a favorable development, signaling that the company’s bonds are outperforming the benchmark yield.
