The yield spread helps investors make decisions. It's the difference between two yields on different debt instruments. Basically, it’s the investor saying, “what’s the opportunity cost of x security over y security? Which will get me a higher yield?”
The debt instruments don’t even have to be that similar. Apples and oranges. Bananas and kiwis. They can have different maturities, credit ratings, and levels of risk.
When looking at a yield spread, it can also help investors choose between debt instruments based on the current versus the historical yield spread. For instance, if something used to have a small return, but now has a large return, it will shrink the yield spread between that debt instrument and another, more stable security. In that case, the investor would probably go with the debt instrument that is doing very well now compared to before, since it’s attractive, with a current yield that’s higher than it was previously.
Related or Semi-related Video
Finance: What is Dividend Coverage/the D...7 Views
finance a la shmoop what is dividend coverage and what is the dividend payout
ratio? whatever.com has earnings big earnings a hundred million dollars worth
of earnings this year from sales of a whole lot of whatever's the board green [People working in a factory]
lights a dividend payment of 40 million bucks that is the company will pay 10
million dollars to its common shareholders of record four times in
this next year the payout is 40 million because well
you know it's paid out and yeah clever titling know is never a thing on Wall
Street and the payout ratio is 40 over a hundred that hundred million of earnings [Payout ratio calculation appears]
or forty percent well why does the payout ratio even matter?
well companies hate having to cut their dividends and they love raising them if
the former well stock prices usually crash if the latter well they usually go
up and companies love it when their stock prices go up duh so what would [Whatever.com share price rises]
happen if whatever dot-com stumbled in its earnings tumbled and then
shareholders mumbled that the earnings payout ratio had crumbled that is... okay
stop with the rhyming bad timing okay now we're stopping and yeah that is what
if the earnings of whatever.com went down next year to only 50 million
remember they were a hundred million now they're only 50....hmm
problem because now the payout ratio is 80 percent 40 over 50 yeah very
difficult situation the company thought it would have tons of earnings to cover
its dividend at the forty million dollar level more or less forever
but clearly it did not so now what well if earnings recover and go back to a [Man discussing whatever.com's earnings]
hundred million dollars on their way to the 300 million they projected well,
then life is grand no sweat no heavy decisions to be made
but what if earnings fall further to be only thirty million the following year
well then whatever dot-com has to either borrow money or deplete its cash
reserves just to cover its dividend in which case the payout ratio would then
be over a hundred percent meaning that the earnings were 30 million and the [Earnings appear]
dividend was to be forty well then the payout ratio would be 40 over 30
133% ouch can't do that for very long without going bankrupt so payout ratios [Wheel spins and lands on bankrupt]
matter because they give a sense for the safety or certainty that that dividend
will continue at its present rate if the ratio is low well odds are good the
company could certainly afford to raise the dividend over time or at least not
cut it yeah for a very long time ideally and if the ratio is high well your [Dividend cut with scissors]
bottom line may soon be bottoming out back-end load there if i ever saw it...
Up Next
Spread to treasuries is an indication of risk associated with a given debt or bond offering.
What is an Accumulated Dividend? Accumulated dividends are dividends paid on cumulative preferred stock. They are referred to as accumulated becaus...
What is Dividend Yield? Similarly to how a bond’s price and coupon is calculated to determine yield, dividend paying stocks also have a yield asc...