A financial spread is a financial term that describes the difference between the prices of two different investments. In essence, it is the cost of buying one investment and selling another. The spread is usually expressed in terms of percentage points, and it can be positive or negative. When a spread is positive, it means that the investment being sold is more expensive than the investment being bought. Conversely, when a spread is negative, it means that the investment being sold is cheaper than the investment being bought.
What Is a Spread in Finance?
A financial spread is the difference between the prices of two different investments.
Uses or Purpose of Spreads
There are a few different reasons why financial spreads might exist in the market. For example, they may be caused by investors who are trying to protect themselves against risk or by companies that are trying to earn a profit on their transactions. Additionally, spreads can be used as a tool to measure liquidity in the market.
The purpose of a spread is to reduce the risk associated with a particular investment. When used in finance, spreads can be employed in a number of ways:
- To reduce the cost of hedging an investment position.
- As part of a trade strategy, in order to take advantage of price differentials between securities or markets.
- To increase the returns on an investment through increased leverage (margin).
- To provide liquidity to certain market segments.
Types of Financial Spreads
There are many different types of spreads, but some of the most common are listed below:
- The first type is the fixed income spread. This is the difference between the interest rates of two different investments. For example, if you have a five-year bond that pays 5% interest and you can buy a ten-year bond that pays 6% interest, then the fixed income spread is 1%.
- The second type is the currency spread. This is the difference between the exchange rates of two different currencies. For example, if you have one British pound and it can buy 1.5 American dollars, then the currency spread is 0.5 (or 50%).
- The third type is called a credit spread. This is the difference between two different credit ratings.
How to Calculate a Spread?
There are a few ways to calculate a spread:
- The most common way is to use the futures or forward prices of the two securities.
- Another way is to use the spot prices of the two securities.
- The third way is to use the implied volatility of the two securities.
The most common way to calculate a spread is to use the futures or forward prices of the two securities. For example, let’s say that you want to buy IBM stock and sell Microsoft stock. You can find the IBM future price and Microsoft future price on Yahoo Finance or any other financial website. Add these two numbers together and this will be your spread calculation.
