what’s a bond spread in economics/finance?


Here’s the full sentence for context: “In 2009, Greece’s budget deficit exceeded 15% of its GDP. Fear of default widened the 10-year bond spread and ultimately led to the collapse of Greece’s bond market.”

In: 3

Bonds are like loans that get paid up all at once in the future. So if I buy a bond from a government, I get nothing for a period of time and then they give me the loan amount, PLUS some amount of interest for the loan.

For example, I can buy a 2 year bond or a 10 year bond from a Government, and I’ll get paid out after either 2 years or 10 years. Each bond will have an interest rate so I make profit on the bond.

But what happens if the economy is tanking? What if I think there is a really good chance my Government is going to go broke? Do I want to give them a 10 year loan? Heck no, I’ll take the 2 year bond please. Get in and get out.

So if the Greek Government was offered 2 year and 10 year loans, in good times, you might expect to see a lot of 10 year *and* 2 year loans, maybe more 10 year because people trust they’ll make a ton of profit in 10 years.

In the case of your example, Greece was struggling hard core and people got nervous and suddenly no one wanted 10 year bonds, and everyone was jumping on 2 year bonds.

The difference in desirability between the 2/10 year bonds is the spread and seeing a huge spread start appearing like is an indicator that *people think* the Government is in trouble. Again, it’s not a guarantee or a direct effect, but something an economist can point to, with numbers, and say “shits fucked”.

It’s a measure of how much more interest a certain country (Greece) has to pay in exchange for a loan (bond) in comparison to a more reliable country ( usually Germany) for the same kind of loan. It’used to measure how much trust banks and other investor have in a country to pay their loan back.

For example: Greece and Germany both needs money. Germany emits some 1000€ bonds, which it will pay back in 10 years, with interest ( let’s say, 1%/year). Greece emits the same bonds, but investor prefer to buy german bonds, as they think it is less risky.
So Greece has to offer more interest to get someone to buy their bond; let’s say, 2%/year

Now, something came up (recession), and it made Greek bonds even more unreliable. So the government has to offer even more interest in exchange for the loan to attract investor (let’s say, 4%/year)
The difference in yield has increased from 1%/year (spread 100) to 3%/year (spread 300)

First, you have to understand what a yield is. Let’s say I’m a country government, and I need to issue debt to finance my budget. I go to the market to say, “Hey, who wants to give me a bond for $1,000? I’m offering 5% coupon.” The market may say, “Sure, 5% sounds reasonable for a country of your risk. Here’s your $1,000.” Now, let’s say I’m Greece, and the market says, “Woah, you’re super risky, very good chance I don’t get paid back in full. I won’t give you your $1,000. However, I will give you $900 for that bond. To be clear, I give you $900 today, then you pay me 5% coupons and at the end of the bond’s term you give me the full $1,000 back.” And I’m desperate, so I take the deal. Even though the coupon is the same, the face value is the same the investor will now make a greater return (called a yield) on the bond due to the lower buy-in price (the actual yield number is calculated based on a standard formula). Now, if I’m the country this is a problem, as I now have to pay more money to be able to finance my government.

A bond spread is the difference in yield between two different bonds. The idea is to try and take out noise of the general capital market conditions/interest rates to capture the true market view of the asset. My guess is that the article is comparing 10-year Greek to 10-year Germany at the time, in other words Greek 10-year yield minus German 10-year yield, but they don’t actually show the spread, they just say the spread widened and then quote the yield.

The reason why it is an issue is because it meant Greece was unable to raise any more money at that point. Even if they raised money at 35% yield, the coupon and principle payments would have drained them very quickly thereafter. The “collapse” was basically the market saying, “I will not lend to you unless you give me absurdly unreasonable terms because you’re not making good on your current obligations and so that means it’s almost certain I won’t get the full face value of the bond back.” And if it can’t pay for basic services, pensions etc., I suppose the issue with that is self-explanatory.