Credit spreads, bond trading and realised return

Basis points over the curve

A corporate bond is priced off the Government of Canada bond of the same maturity. The difference between the two yields is the credit spread, quoted in basis points (1 bp = 0.01 %). Tamarack Foods' 10-year yields 6.85 % while the 10-year GoC yields 4.10 %:

=(0.0685-0.041)*10000 = 275 bp.

The spread is the market's price for Tamarack's default risk and thinner liquidity (Lessons 9.6, 9.2). It widens in recessions — investors demand more for the same credit — and narrows when the rating improves or the economy calms. Read the sign carefully: if the GoC curve is flat and Tamarack's spread widens from 275 to 325 bp, Tamarack's yield rose 50 bp, so its price fell — a spread move is a price move for the corporate alone. The spread is over the GoC yield of the same maturity, never over prime and never in dollars.

How a bond actually trades

Unlike a TSX share, a Canadian bond trades in a dealer market — over the counter, by phone and electronic platform, with the dealer acting as principal from its own inventory (Lesson 3.2). Dealers quote a bid and ask in price per 100 (Lesson 9.7) but talk in yield — "Tamarack 10s at plus 275" is a complete quote once the GoC benchmark is known. Minimum sizes are large; retail investors buy from a dealer's inventory at a mark-up rather than at an exchange price. Settlement is T+1 (since 27 May 2024, with the equity market), and post-trade prices are published through the CIRO information processor for corporate and government debt — the transparency an exchange gives shares by default.

Worked example — realised return on an early sale

Halton Dairy buys Prairie Grid's 5.2 % ten-year at a 6 % yield — 940.49 — holds it two years, collecting four coupons of 26 (104), then sells when yields have fallen to 5 %. The sale price is not the purchase price and not par; it is a fresh PV at the new yield with the remaining periods — 8 years, 16 half-years:

=-PV(0.025,16,26,1000) = 1,013.06

$$HP{R}_{2\text{yr}}=\frac{1,013.06-940.49+104}{940.49}=18.77\%$$

Annualised over two years: =(1+0.1877)^(1/2)-1 = 8.98 % a year — better than the 6 % YTM bought, because yields fell and the price rose beyond the pull to par. Read the question: it may want the two-year total (18.77 %) or the annual figure (8.98 %).

Recompute

Yields rise to 7 % instead: =-PV(0.035,16,26,1000) = 891.15; HPR = (891.15 − 940.49 + 104)/940.49 = 5.81 % over two years, 2.87 % a year — below the 6 % YTM, because the price fell. Cold: the sale price is a new PV because the buyer prices the remaining cash flows at the market's rate that day — not the rate you paid.