The term “spread” comes from economics and means the price difference between two economic variables of a unit. The price-related spread is also known as the “bid-ask spread”.
Types of spreads
In the banking world, a distinction is made between different types of spreads:
- The price-related spread
- The spread in the interest rate
- The spread on futures
- The option spread
The price-related spread (bid-ask spread or bid-ask spread)
In the case of securities, the price-related spread, also known as the bid-ask spread, reflects the difference between the bid and ask price (bid-ask spread). Ask price stands for the price that a buyer is willing to pay (ask), the bid price for the price that the seller expects (bid). If there is a “B” behind a share on the price sheet, it means there was a demand, but no supply. If there is a “G” behind it, there was an offer, but nobody wanted to buy the paper.
According to digopaul, the price-related spread does not only apply to stocks , but generally to securities, currencies, raw materials and precious metals. Investors who trade CFDs (contracts for difference) know the spread as the basis for calculating the broker’s commission . The price-related spread is an indicator of the transaction costs that an investor incurs in a trade and is determined as follows: Spread = ask price – bid price.
Spread for Pfandbriefe
However, the spread also plays a role with Pfandbriefe . As part of the market making of Jumbo Pfandbriefe, there is a fixed spread that is based on the term of the bond .
- Term up to three years: 0.05 cents
- Duration three to six years: 0.06 cents
- More than six years to eight years: 0.08 cents
- More than eight years: 0.10 cents
The spread in the interest rate
The capital markets do not offer a uniform interest rate, but a wide variety of interest rates . The difference between two interest rates is known as the interest spread. The yield curve can be derived from the interest rate spread, for example when comparing the historical interest rate development between bonds with a term of ten years on the one hand and bonds with a term of 20 years on the other.
The so-called credit spread is the difference between the interest on a low-risk investment and the interest on a bond with a credit default risk. In this case, the higher the spread, the riskier the investment.
The importance of the interest rate spread for current capital market analyzes
Rating agencies consider a situation to be observed in retrospect. The spread on interest rates is immediately noticeable. It also functions as a leading indicator. Just as the market price of a share reflects investors’ expectations of the company for the future, the interest rate spread not only reflects the creditworthiness of an issuer of a bond at the time of issue . It also shows what market participants expect from the issuer’s future creditworthiness.
Forward transactions, whether with securities, foreign exchange or goods (English commodities) are something for experienced investors. Anyone who makes a spread on the futures market buys and sells an underlying asset with different contract terms at the same time. This spread can take place on the same market, even on different exchanges. It can also be based on different base values. The background to such a spread is not the price change in one of the two trades, but the relative price change between the purchase and the sale.
The spread as an option strategy
The term “spread” also stands for a specific strategy when trading derivatives . The strategy is based on the fact that a trader enters into two options on the same underlying asset as a call or a put option and buys in one case and sells in the other. The difference between the two options lies in a different base price and a different duration. If the price of the option sold is higher than the price of the option bought, the trader has made a surplus.