Term spread
The difference in yield between two bonds of the same issuer at different maturities — the workbook's own example is the gap between a 10-year and a 2-year G-Sec.
In plain language
A 2-year government bond and a 10-year government bond rarely yield the same. The gap between them has a name.
Term spread is the difference in interest rate between two different time periods, for otherwise similar bonds. When the economy looks uncertain, investors want more compensation for locking money away for longer, so the spread tends to widen. When confidence returns, it tends to narrow.
A portfolio manager tracking the term spread is really tracking investor sentiment about the future, through the yield curve it comes from.
How it works
The workbook's own worked example (section 19.3, Yield Spread Analysis): the term spread between a 10-year G-Sec yielding 6.0% and a 2-year G-Sec yielding 4.3% is 1.7%.
Term spread = Long-term yield − Short-term yield = 6.0% − 4.3% = 1.7%
The workbook's explanation for why this number moves: the spread widens during periods of economic uncertainty and recession, because investors demand larger risk premiums for longer commitments, and it declines during periods of economic confidence and expansion. A portfolio manager forecasts the direction of the spread and builds the bond portfolio's maturity mix accordingly.
A worked example
Following the workbook's own G-Sec figures, extended. On a given day, the 10-year G-Sec yields 6.0% and the 2-year G-Sec yields 4.3% — a term spread of 1.7%, exactly the workbook's figure.
Six months later, amid signs of an economic slowdown, the 10-year yield rises to 6.6% while the 2-year yield, more sensitive to the current policy rate, falls to 4.0% as the central bank signals rate cuts. The term spread widens to 6.6% − 4.0% = 2.6%, just as the workbook's logic predicts for a period of economic uncertainty.
A fixed-income portfolio manager holding Rs 5,00,00,000 in the 2-year G-Sec, having expected this widening, benefits because a widening term spread here also meant the 2-year yield fell — and its price rose.
Why NISM asks about it
Chapter 19 (Fixed Income Portfolio Management Strategies), section 19.3 (Active Management Strategy: Yield Spread Analysis), defines term spread with the 10-year-versus-2-year G-Sec example and its 1.7% figure, and links spread direction to the economic cycle. Expect a direct calculation question using the 6.0%/4.3% figures or similar, and a question on which economic condition widens or narrows the spread.
Common exam traps
- The workbook's own worked figures are 6.0% and 4.3%, giving a 1.7% term spread — these are G-Sec yields at two different maturities of the same issuer, not a credit spread between different issuers.
- The spread widens in uncertainty and recession, and narrows in confidence and expansion — this direction is easy to flip under exam pressure; anchor it to 'longer money needs a bigger reward when the future looks riskier.'
- Term spread is not credit spread — term spread compares maturities within one issuer; credit spread compares issuers of different credit quality at the same maturity.
Check yourself
1.The 10-year G-Sec yields 6.0% and the 2-year G-Sec yields 4.3%. What is the term spread, and how does the workbook expect spreads to behave in a recession?
- a)1.7%; spreads narrow in recession
- b)1.7%; spreads widen in recession
- c)10.3%; spreads widen in recession
- d)1.4%; spreads do not change with the economy
Show the answer
Answer: (b) 1.7%; spreads widen in recession
Term spread = 6.0% − 4.3% = 1.7%. The workbook says spreads widen during economic uncertainty and recession, as investors demand larger risk premiums, and decline in periods of confidence and expansion.
Option A reverses the cycle. Option C adds instead of subtracting.
Where this is taught
Free preparation for NISM Series XXI-BRelated terms
- Credit spreadThe extra yield a non-government borrower must pay over a government security of the same tenor — the market price of credit risk, quoted as an add-on over the risk-free rate.
- Parallel shiftA change in the term structure in which all rates move in the same direction by the same extent, leaving the spread between short and long rates unchanged — the only kind of move duration handles well.
- Term structure of interest ratesInterest rate plotted against term — one curve per credit quality, with the risk-free curve as the base and every other borrower quoted as a spread over it.
- TwistA steepening or flattening of the yield curve in which short-term and long-term rates move in opposite directions — as distinct from a convexity change, where they move the same way by different amounts or one stays put.
- Three S's of the yield curveThe workbook's own name for the three ways a yield curve can move — Shift, Slope and Shape — that a fixed income manager watches when taking an interest-rate view.