Credit Risk Management Practice Exam

What does the yield spread calculate?

1. Yield - benchmark yield

2. CDS premium charge for potential default

3. Difference between total returns and market returns

4. Future value of debt obligations

The correct answer is: Yield - benchmark yield

The yield spread calculates the difference between the yield of a security and the yield of a benchmark security, often a risk-free government bond. This is typically expressed as the yield of the security minus the benchmark yield. The yield spread serves several purposes in credit risk management, such as assessing the risk premium investors require to hold a security over the benchmark, reflecting the creditworthiness of the issuer. For example, a wider yield spread might indicate higher perceived risk, while a narrower spread could suggest lower risk or increased demand for the security. This measure is vital for investors making comparisons between different types of bonds or assessing the investment’s risk profile. In contrast, the other options do not accurately reflect what yield spread calculates. The CDS premium focuses on credit default swaps, not just yield. The difference between total returns and market returns relates to performance metrics rather than yield comparison. Future value pertains to the projected worth of cash flows over time and does not describe the concept of yield spread.