I-spread

The I-spread is the distance between the yield of a particular bond and the interest rate swap rate for a comparable maturity, expressed in basis points. It answers the question of how much more the issuer pays to borrow compared with the level at which market participants exchange fixed and floating payments — in other words, it compares the bond not with government debt but with the bank funding rate.

Where the benchmark comes from

A swap rate for the exact maturity of the bond is usually not quoted in the market: the swap curve exists as a set of nodes for standard maturities. The rate matching the duration or the time to maturity of the issue is therefore obtained by interpolating between the neighbouring nodes — hence the word "interpolated" in the English name. The resulting rate is then subtracted from the yield of the issue. The yield used is the one at which the bond actually trades: the yield to maturity, and for a bond with a put option the yield to put, otherwise the maturity and the benchmark will drift apart.

The floating leg of the swap is tied to the money market, and its level reflects the cost of short-term roubles — in the Russian setting the reference is RUSFAR. This is why the I-spread shifts not only when the issuer's credit quality changes, but also when the market reprices the path of the key rate: the yield of the issue and the swap rate respond to expectations differently, and the difference between them moves of its own accord.

An example using exchange data

A spread to swaps is worth calculating where the bond has a stable market price rather than a single trade per day. Liquid issues can be seen in the ranking by turnover:

For each line in this list, one takes the yield at the moment of calculation, selects the swap curve nodes around the maturity of the issue and looks at the difference. For bonds with a comparable maturity but a different credit rating, the gap between the spreads is precisely the price paid for credit risk.

Where the measure stops working

The I-spread describes a fixed-coupon bond. A floater's coupon resets itself in line with the money market, and subtracting a fixed swap rate from its notional yield produces a figure with no economic meaning — for such issues one looks at the floater duration and the premium over the base rate.

The second limitation is sensitivity to the shape of the curve. If the swap curve is kinked, the result of the interpolation depends on the method chosen to connect the nodes, and the spread of one and the same bond will differ from one calculation agent to another. Where precision matters along the whole length of the payment stream, the spread to a single point is replaced by the Z-spread — a shift applied to the entire discount curve at once.