Financial matters

A spread-based payment

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The credit spread is measured by comparing a company’s bond yields against those of Treasury notes with similar structure and term. If the bond’s credit spread rises above a predetermined level the contract pays out on a notional principal outstanding based on the difference between the actual spread and that defined in the contract.
This is best illustrated with an example. Suppose that the contract is for a notional principal of $100m and that the issuer will pay out if the credit spread reaches more than 500 bpts above the yield on a specified, comparable Treasury note. At 600 bpts the annual payment from the issuer of credit derivative would be $1m.