What is 'Credit Spread' in the bond market?

[ A ]The interest rate charged by the Reserve Bank of India to commercial banks under repo auctions.

[ B ]The annual fee charged by credit card companies to merchants.

[ C ]The profit margin earned by a stockbroker on equity trades.

[ D ]The difference in yield between a corporate bond and a sovereign government bond (G-Sec) of identical maturity, compensating investors for credit default and liquidity risk.[ CORRECT ]

Takeaway

Credit spread is the extra yield a corporate bond offers over a G-Sec of the same maturity, compensating investors for the corporate issuer's default risk and the bond's relatively lower liquidity.

Derivation

Because a G-Sec carries sovereign backing and is treated as effectively free of default risk, its yield serves as the risk-free benchmark for a given maturity. A corporate bond of identical tenor must offer a higher yield to compensate investors for two things a G-Sec doesn't carry: the probability the issuer could default on interest or principal, and typically thinner secondary-market liquidity. Credit Spread = Corporate Yield - G-Sec Yield, and this spread is not static — it widens sharply during economic stress or credit downgrades (flight to safety into G-Secs) and narrows during expansions, making it a widely-tracked barometer of market-wide credit risk appetite.

Why the others fail

A — The interest rate charged by the Reserve Bank of India to commercial banks under repo auctions.

The repo rate is RBI's policy tool for overnight liquidity operations with banks, not a market-determined yield differential between two bond categories.

B — The annual fee charged by credit card companies to merchants.

The merchant discount rate (MDR) is the fee card networks/banks charge merchants for processing transactions — an entirely separate payments-industry concept.

C — The profit margin earned by a stockbroker on equity trades.

Brokerage commission is the fee a stockbroker earns for executing equity trades; it has no relationship to the yield differential between two classes of bonds.