Spread is a concept investors use in different ways to evaluate different investment options. Two popular spread calculations are the bid-ask spread of individual stocks and the yield spread of two bonds or similar debt instruments. For stocks, spread represents the difference between the bid and ask prices at any given point in time. For bonds and debt instruments, spread represents the difference in the yield-to-maturity of two different options. Learning to calculate spread is a must for stock and bond traders.
Calculate Stock Bid-Ask Spread
1. Look up the bid price of the stock in question. The bid price represents the price that the most recent interested buyers are willing to pay for a stock at a given time. Look up your chosen stock on your preferred stock news website, or the website of the exchange on which the stock is listed, to determine the bid price at a point in time.
2. Look up the ask price of the stock. Look near the listed bid price to find the current ask price – most stock news outlets will list both of these figures side-by-side.
3. Subtract the bid price from the ask price to calculate the bid-ask spread. For example, if if a stock's bid price is currently $15, and the ask price is currently $16, subtracting the ask from the bid would result in a spread that would come out to $1.
Calculate Bond-Yield Spread
1. Write down the annual coupon payment amounts, number of years to maturity, par value and purchase prices of both bonds. The annual coupon payment equals the dollar amount received for interest each year, not the interest rate. Subtract the current age of the bond from its total payback period to find the number of years left until maturity. The par value represents the purchase price listed on the bond, and the purchase price variable represents what you actually paid for the bond.
2. Determine the yield-to-maturity (YTM) of both bonds. Plug the variables listed above into a free online YTM calculator to quickly determine the YTM of both options, as the formula is more complex and time-consuming than other investment-related metrics. If you wish to perform the calculation by hand, use the following formula to solve for YTM, where C = the annual coupon payment, Y = the number of years to maturity, B = the par value and P = the purchase price: C(1 + YTM) ^ -1 + C(1 + YTM) ^ -2 + … + C(1 + YTM) ^ - Y + B(1 + YTM) ^ - Y = P
3. Subtract the YTM of the first bond from the YTM of the second bond to determine the yield spread. Read the bond-yield spread in terms of basis points rather than dollars. For example, if one bond's YTM is .08 and another's is .07, the spread would be one basis point, or .01.
- Stock spreads can change daily, hourly or even by the minute. Set up a spreadsheet formula to allow you to quickly re-calculate stock spreads several times throughout the day to save time compared to performing the calculation by hand every time.
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