{"id":3480,"date":"2019-09-06T12:00:00","date_gmt":"2019-09-06T12:00:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=3480"},"modified":"2026-01-09T15:07:04","modified_gmt":"2026-01-09T15:07:04","slug":"credit-spread-liquidity-yield-maturity","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/fixed-income\/credit-spread-liquidity-yield-maturity\/","title":{"rendered":"Effect of Credit Spread on Yield-to-maturity"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Understanding Fixed-Income Risk and Return (2025 Level I CFA\u00ae Exam \u2013 Fixed Income \u2013 Module 5)\",\n  \"description\": \"This video lesson covers key concepts in fixed-income analysis, including sources of return for fixed-rate bonds, duration measures (Macaulay, modified, effective), convexity, and yield curve sensitivity. It also explains how credit spreads, liquidity, and term structure volatility impact bond prices and interest rate risk using analytical tools like duration and convexity.\",\n  \"uploadDate\": \"2022-06-01T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/ys7hMfL_EIs\/maxresdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=ys7hMfL_EIs\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/ys7hMfL_EIs\",\n  \"duration\": \"PT1H1M0S\"\n}\n<\/script>\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"What is the credit risk implied by the bond\u2019s yield and liquidity spread?\",\n    \"text\": \"The yield-to-maturity of a corporate bond is 8% while the yield of a similar risk-free government bond is 3%. If the liquidity risk is assumed to be 1.75%, which of the following is closest to the credit risk on this bond?\\n\\n2.75%\\n3.25%\\n5%\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is 3.25%. The yield spread is 8% minus 3%, which equals 5%. Since the spread is the sum of credit risk and liquidity risk, 5% = credit risk + 1.75%. Therefore, credit risk = 5% \u2212 1.75% = 3.25%.\"\n    }\n  }\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/ys7hMfL_EIs?si=vCiv4KMNeZhRyF5x\" title=\"YouTube video player\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe>\n\n\n\n<p>The yield-to-maturity on a corporate bond comprises a government benchmark yield and a spread over that benchmark.<\/p>\n\n\n\n<p>The building-blocks approach implies that the yield-to-maturity changes can be broken down further. The benchmark yield could change either because of a change in the expected inflation rate or a change in the expected real interest rate. Furthermore, a spread change could also arise due to a change in the issuer&#8217;s credit risk or because of the liquidity of the bond.<\/p>\n\n\n\n<p>Assume that a bond with a modified duration of 4.00 and a convexity of 25.00 will appreciate by around 0.81%, regardless of the source of the yield-to-maturity change, if the yield-to-maturity decreases by 20 bps.<\/p>\n\n\n\n<p>$$ \\%\u0394PF^{FULL}\u2248(-4.000\u00d70.0020)+(\\frac{1}{2}\u00d725\u00d7(-0.0020)^2 )=0.0081 $$<\/p>\n\n\n\n<div style=\"margin: 0 0 20px 0;\">\n  <a\n    href=\"https:\/\/analystprep.com\/free-trial\/\"\n    target=\"_blank\"\n    rel=\"noopener noreferrer\"\n    style=\"\n      display: inline-block;\n      border: 2px solid #1e63ff;\n      color: #1e63ff;\n      background: #ffffff;\n      padding: 10px 14px;\n      border-radius: 10px;\n      font-weight: 500;\n      line-height: 1.35;\n      text-decoration: none;\n    \"\n  >\n    Want to analyze how credit spreads, liquidity, and maturity affect bond yields? Try AnalystPrep\u2019s free trial now.\n  <\/a>\n<\/div>\n\n\n\n<h2><strong>Credit Risk<\/strong><\/h2>\n<p>Let\u2019s now assume that the yield to maturity on a corporate bond is 6.75%. When the\u00a0benchmark (government) yield\u00a0is 4%, the\u00a0spread\u00a0is 2.75%, which is the difference between the benchmark yield and the yield on our bond.<\/p>\n<p>In the fixed-income market, credit risk is referred to as the probability of default and the recovery of assets in case of default. Our example assumes that credit risk is estimated to be 2.25% from the spread of 2.75%, and liquidity risk represents the remaining 0.50%.<\/p>\n<h2><strong>Liquidity Risk<\/strong><\/h2>\n<p class=\"Text001\"><span class=\"Style2AltBaslikChar\"><span lang=\"EN-US\">Liquidity risk <\/span><\/span><span lang=\"EN-US\">is smaller when there is a greater frequency of trading and higher volumes of trading.<\/span><\/p>\n<p class=\"Text001\"><span lang=\"EN-US\">There is a difference between the <span class=\"Style2AltBaslikChar\">bid<\/span> (or purchase) price and the <span class=\"Style2AltBaslikChar\">offer<\/span> (or sale) price. The difference depends on the type of bond, the size of the transaction, among some other factors. For instance, government bonds often trade just a few basis points between purchase and sale prices. On the other hand, thinly<span class=\"Style2AltBaslikChar\">\u00a0traded<\/span> corporate bonds could have a\u00a0 wider difference between bid and offer prices, creating more liquidity risk if the investor wishes to sell his bond.<\/span><\/p>\n<blockquote>\n<h3><strong>Question<\/strong><\/h3>\n<p>The yield-to-maturity of a corporate bond is 8% while the yield of a similar risk-free government bond is 3%. If the liquidity risk is assumed to be 1.75%, which of the following is <em>closest<\/em> to the credit risk on this bond?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">2.75%<\/li>\n<li data-tadv-p=\"keep\">3.25%<\/li>\n<li data-tadv-p=\"keep\">5%<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>Spread = 8% &#8211; 3% = 5%<\/p>\n<p>Spread = Credit risk + Liquidity risk<\/p>\n<p>5% = Credit risk + 1.75%<\/p>\n<p>Credit risk = 5% &#8211; 1.75% = 3.25%<\/p>\n<\/blockquote>\n\n\n<div style=\"text-align: center; margin: 32px 0;\">\n  <a\n    href=\"https:\/\/analystprep.com\/free-trial\/\"\n    target=\"_blank\"\n    rel=\"noopener noreferrer\"\n    style=\"\n      display: inline-block;\n      background-color: #1e63ff;\n      color: #ffffff;\n      padding: 12px 26px;\n      border-radius: 12px;\n      font-weight: 600;\n      font-size: 16px;\n      text-decoration: none;\n    \"\n  >\n    Start Free Trial \u2192\n  <\/a>\n\n  <div style=\"margin-top: 10px; font-size: 14px; color: #374151;\">\n    Explore how credit spreads, liquidity, and maturity shape bond yields using real-world examples and guided practice.\n  <\/div>\n<\/div>\n\n","protected":false},"excerpt":{"rendered":"<p>The yield-to-maturity on a corporate bond comprises a government benchmark yield and a spread over that benchmark. The building-blocks approach implies that the yield-to-maturity changes can be broken down further. The benchmark yield could change either because of a change&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[9],"tags":[],"class_list":["post-3480","post","type-post","status-publish","format-standard","hentry","category-fixed-income","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Technical vs. Fundamental Analysis | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Compare technical and fundamental analysis, exploring price trends, volume data, and external market factors to forecast security movements.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" 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