What is the Credit Curve?

What is the Credit Curve?

The credit curve is the graphical representation of the relationship between the return offered by a security (credit-generating instrument) and the time to maturity of the security.

 It measures the investors’ sentiments about risk and can affect the return on investments. The difference between the first maturity on the curve (the short end) and the last maturity of the curve (on the long end) determines the steepness of the curve.

How are Credit Curves Used?

The credit curve shows a range of maturities at various interest rates. They can vary by investment. One of the most important uses of the yield curve is its ability to predict the movement and strength of the economy.

The Treasury yield curve is the most often used credit curve. It is used as a benchmark curve against which all other credit curves are measured. The yield of the Treasury curve is usually low as it is backed up by the government. However, it can be used as a benchmark for riskier bonds such as AAA-rated corporate bonds.

The difference between agency bonds and a government bond is called the “spread.” If the difference between the two is low, it makes the investor more confident in investing in the bond that is not backed by the government. The difference in the bonds (spread) is increases during a recession as agency bonds become riskier. It decreases when there is growth in the economy as the bonds are now safer to invest in.

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