Credit spread is a measure of the difference between the yield on a risky and a risk-free security, typically a corporate bond and a government bond respectively (although other reference assets may be used, e.g. swaps). It reflects the expected cost of default, a risk premium relating to the risk of default, and a liquidity premium.
There are three common measures of credit spread. The nominal spread is simply the difference between the gross redemption yields of risky and risk-free bonds. The static spread is the addition to the risk-free rate at which discounted cash flows from a risky bond will equate to its price. The option-adjusted spread further adjusts this discount rate through the use of stochastic modelling to allow for any options embedded in the bond. [Source: Institute and Faculty of Actuaries (IFoA) Enterprise Risk Management Specialist Principles (SP9) Core Reading]
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