How to Calculate Bond-Risk Spread
- 1). Look at the return U.S. Treasury bonds are paying. This is the baseline standard. The riskier the other bonds, the bigger the spread there should be between the yield of a risky bond and the yield of the Treasury bond.
- 2). Calculate the debt-to-asset ratio of the companies represented by the bond you want to buy. Do this by dividing the company's total debt by the appraised value of its assets. You can find this information in the company's Securities and Exchange Commission (SEC) filings. Companies are required to file reports with the SEC once to twice a year, depending on the company structure. The lower this ratio, the less risk the company carries. The higher the ratio, the higher the risk.
- 3). Look at the Standard and Poor (S&P) rating of the bonds you're evaluating. The highest-rated bonds are rated AAA. The lowest are rated C. Examine the spread in yields between bonds of different ratings. Compare these to the spread six months ago, a year ago, two years ago or any other increment of time you prefer. Decide whether the spread is narrowing or widening. Your answer will help you determine whether you think the current spread justifies the risk.
- 4). Research whether interest rates are going to rise, fall or remain steady. If interest rates are going to rise, then there is more risk in carrying a long-term bond, because the price of long-term bonds fall when interest rates rise. (Bond prices and yields move in opposite directions.) If interest rates will fall, there is more risk in short-term bonds. Consider the spread between short-term and long-term bonds and the current interest rate situation when deciding whether or not you believe the spread between yields justifies the risk. Your answer will depend heavily on the current economic forecast.
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