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CFA Level I Exam · Credit Analysis for Corporate Issuers

Credit Spreads, Ratings and Yield Spread Analysis

Updated 7 October 2026 · Fact-checked

A credit spread is the extra yield a corporate bond pays over a benchmark government bond of similar maturity. It pays you for default risk, loss severity and liquidity. Spreads widen when credit quality falls or the economy weakens, and narrow when conditions improve. Ratings summarize credit quality.

Understand Credit Spreads, Ratings and Yield Spread Analysis

A credit spread is the yield on a risky bond minus the yield on a benchmark bond with the same maturity, usually a government bond. If a 5-year corporate bond yields 5.40% and the 5-year government bond yields 4.10%, the spread is 1.30%, or 130 basis points. The spread is your compensation for taking credit risk.

Credit risk has two parts: probability of default and loss severity (loss given default, which is 1 minus the recovery rate). A bond with a higher chance of default, lower expected recovery, longer maturity or poorer liquidity needs a wider spread. Spreads also contain a premium for uncertainty and for the market's overall risk appetite, so they can move even when an issuer's fundamentals do not.

Credit rating agencies such as S&P Global Ratings, Moody's and Fitch give opinions on creditworthiness. S&P and Fitch start at AAA and run down to default categories: SD and D for S&P, RD and D for Fitch. Moody's runs from Aaa down to C. Investment grade means BBB- or higher (S&P, Fitch) or Baa3 or higher (Moody's). High yield (speculative grade, or junk) means BB+/Ba1 or lower. The line matters because many institutions can only hold investment grade bonds. A bond that falls below the line can face forced selling, which pushes its spread up sharply.

Notching is the adjustment made to an issuer rating to get the rating of a specific bond. Senior unsecured debt usually gets the issuer rating. Subordinated debt is notched down because its recovery is lower. Secured debt may be notched up. Rating migration is the move of an issuer between rating categories over time. A downgrade usually widens the spread, and an upgrade narrows it. Migration is more likely and more costly for lower-rated issuers.

Spreads are countercyclical, meaning they move opposite to the economic cycle: they tighten in expansions, when profits are strong and defaults are low, and widen in recessions, when defaults rise and investors demand more compensation. High-yield spreads move much more than investment grade spreads. Ratings have limits: they lag the market, can be wrong, and agencies are paid by issuers, which creates a conflict of interest.

Key formulas to remember

Credit spread
Credit spread = Yield on credit-risky bond − Yield on benchmark bond of same maturity
Quote in basis points. 1 bp = 0.01%. Use the same maturity and currency.
Expected loss
Expected loss = Probability of default × Loss given default
Loss given default = 1 − recovery rate. Spreads must at least cover expected loss and add a risk premium.
Approximate price change from spread change
%ΔPrice ≈ −Modified duration × ΔSpread
Holds for a small change in spread with benchmark yield unchanged. Widening lowers price.
Investment grade boundary
Investment grade: BBB- / Baa3 and above. High yield: BB+ / Ba1 and below
Know both scales: S&P and Fitch vs Moody's.

How to solve Credit Spreads, Ratings and Yield Spread Analysis questions

Use this sequence for any question on spreads, ratings or spread changes.

  1. 1Identify what is asked: a spread level, a direction of change, a rating category, or a price effect.
  2. 2Write the spread as risky yield minus benchmark yield, checking maturities match and units are in basis points.
  3. 3List the drivers in play: default probability, loss severity, liquidity, maturity, and market risk appetite.
  4. 4For ratings, place the bond on the scale: investment grade or high yield, then apply notching for seniority.
  5. 5For the economic cycle, link expansion to tighter spreads and recession to wider spreads, with high yield moving most.
  6. 6For price effects, apply −modified duration × change in spread, converting basis points to a decimal.
  7. 7Eliminate the two options that contradict direction, seniority or the investment grade boundary, then check the remaining one.

Quickest way: Direction-first elimination

When to use it: Use for conceptual questions where you must pick the correct direction or ranking of spreads.

  1. Decide the direction first: worse credit, weaker economy or lower liquidity means a wider spread.
  2. Rank by risk: senior secured is tightest, then senior unsecured, then subordinated.
  3. Rank by rating: higher rating means a narrower spread, and high yield reacts most to the cycle.
  4. Cross out options with the wrong direction, then confirm the last one with a quick number check.

Common mistakes in Credit Spreads, Ratings and Yield Spread Analysis

  • Saying spreads narrow in a recession

    Students confuse lower government yields with lower credit spreads.

    Fix: Government yields may fall in a recession, but credit spreads widen because default risk and risk aversion rise.

  • Treating BBB+ or Baa1 as high yield

    The boundary is easy to misplace on the scale.

    Fix: Investment grade runs down to BBB- or Baa3. High yield starts at BB+ or Ba1.

  • Mixing up Moody's and S&P notation

    The scales look similar but use different letters.

    Fix: Moody's uses Aaa, Aa, A, Baa, Ba, B, Caa with numbers 1-3. S&P and Fitch use AAA, AA, A, BBB, BB, B, CCC with + and -.

  • Notching subordinated debt up or giving it the issuer rating

    Students forget that recovery depends on priority of claims.

    Fix: Subordinated debt has lower recovery, so it is notched down. Senior secured can be notched up.

  • Ignoring the spread when comparing yields

    Students compare raw yields across bonds of different maturities or currencies.

    Fix: Compare spreads over the matching benchmark so you isolate credit compensation.

  • Using the full yield change in the price approximation

    The question gives a spread change but students add benchmark moves too.

    Fix: If only the spread changes, use ΔSpread alone. Add benchmark yield change only when stated.

Worked examples

Example 1

A 7-year corporate bond yields 6.15%. The 7-year government bond yields 4.85%. The bond has a modified duration of 5.2. If the spread widens by 40 bps and the government yield is unchanged, what is the approximate percentage price change? A) −2.08% B) −0.21% C) +2.08%

Show the solution
  1. Current spread = 6.15% − 4.85% = 1.30%, or 130 bps.
  2. Spread change = +40 bps = +0.0040.
  3. Price change ≈ −5.2 × 0.0040 = −0.0208.
  4. Convert to percent: −2.08%.

Answer: A) −2.08%. Wider spread with unchanged benchmark yield lowers the price. Option B is off by a factor of 10 (a scale error) and understates the price change. Option C has the wrong sign.

Example 2

An issuer is rated BBB- by S&P. A rating agency notches its subordinated debt down two levels. Which statement is correct? A) The subordinated debt is investment grade and has the same recovery as senior debt. B) The subordinated debt is high yield and is expected to recover less than senior debt. C) The subordinated debt is high yield and is expected to recover more than senior debt.

Show the solution
  1. Start at BBB-, the lowest investment grade rating.
  2. Two notches down: BBB- to BB+ to BB.
  3. BB is below the boundary, so the bond is high yield.
  4. Subordinated claims rank behind senior claims, so expected recovery is lower.
  5. Option A is wrong on category and recovery. Option C is wrong on recovery.

Answer: B) The subordinated debt is rated BB, which is high yield, and it is expected to recover less than senior debt.

Exam tips

  • Direction questions are common: tie every spread move to credit quality, the cycle or liquidity, then pick the matching option.
  • Memorize the investment grade line on both scales, since options often test BBB- versus BB+.
  • Remember that high-yield spreads are more sensitive to the economy than investment grade spreads.
  • For price effects, convert basis points to decimals and watch the sign.
  • With no penalty for wrong answers, always answer. Eliminating two options on direction or seniority gives a strong guess.

Practice questions from Credit Analysis for Corporate Issuers

Credit Spreads, Ratings and Yield Spread Analysis in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Credit Spreads, Ratings and Yield Spread Analysis: frequently asked questions

What drives credit spreads?

The main drivers are probability of default, loss severity, liquidity, maturity and overall market risk appetite. Worse credit quality, longer maturity and lower liquidity all widen the spread.

What is the difference between investment grade and high yield?

Investment grade bonds are rated BBB- or Baa3 and above. High yield bonds are rated BB+ or Ba1 and below. High yield bonds have higher default risk and pay wider spreads.

What are notching and rating migration?

Notching adjusts an issuer rating up or down for a specific bond based on seniority and security. Rating migration is the change of an issuer's rating over time, and downgrades usually widen spreads.

How do credit spreads change over the economic cycle?

Spreads tighten in expansions as profits rise and defaults fall. They widen in recessions as default risk and risk aversion rise. High-yield spreads swing more than investment grade spreads.