What Does Having a Wider Spread in Finance Mean?

The term spread is used several ways in finance, lending and investing. The most common usage is in interest rates. Interest rates from savings, borrowing and investing can be compared by looking at the spread between two rates and how they affect the involved parties.

Banking Spreads

The profitability of a bank is based on the interest rate spread between what a bank pays on customer deposits and the rates at which it lends money. For example, a bank paid an average of 0.89 percent on deposits and charged an average of 4.40 percent on loans, resulting in an interest rate spread of 3.51 percent. If a bank can widen this spread by charging higher loan interest rates, the bank can increase its profitability.

Leading Indicator Spread

The Conference Board uses an interest rate spread as one of the indicators in the board's widely followed index of leading economic indicators. The spread used by the Conference Board is the difference in yield between the 10-year Treasury bond and the federal funds target rate. This is a spread between short-term and long-term interest rates. An increase in this interest rate spread can be a sign of increasing economic activity.

Credit Rating Spreads

Another widely followed financial spread is the interest rate spread between U.S. Treasury securities and high yield bonds. Treasuries are among the safest debt investments, and high yield bonds are those with credit ratings below investment grade. This spread is the premium low credit quality bond issuers must pay to borrow money over the rate of safe Treasury bonds. An increase in the credit spread indicates investors think there is a higher probability of default from riskier bond issuers. The spread often increases when economic activity slows.

Price Spreads

With every type of marketable or tradeable financial instrument is a spread between what a buyer is willing to pay and the price at which a seller has indicated he will sell. This spread is the bid-ask spread. Stocks, bonds, options and futures all have bid-ask spreads on their market quoted prices. A wider spread in this context indicates either a low volume of trading action or that the market makers in the particular security expect a higher level of volatility.

References

• Federal Reserve Bank of San Francisco; What Determines the Credit Spread?; December 2004
• The Asset Allocation Advisor: High Yield Bond Credit Spreads
• The Conference Board; Global Busines Cycle Indicators; August 2011
• M&T Bank: M&T Bank Corporation Announces Second Quarter Profits; July 2011
• Investor Home; The Bid-Ask Spread and Market Making; Gary Karz