TED Spread

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The term "TED spread" ("T" for Treasury, "ED" for Eurodollars[1]) refers to the difference in the spread between the purchase and sale of a 3-month U.S. Treasury bill futures contract and a 3-month Eurodollar futures contract. The TED spread focuses on the amount of yield that results from the combination of a purchase and a sale of the two different contracts. In addition to its use as a potentially lucrative investment move, the TED spread can also serve as an indicator of credit risk.[2] [3]

On Sept. 17, 2008 credit crisis concerns caused the yield spread between the two instruments to reach its widest point since the October of 1987 stock crash.

The TED spread is a measure of liquidity and shows the degree to which banks are willing to lend money to one another. It can be used as an indicator of credit risk because U.S. T-bills are considered risk free while the LIBOR rate reflects the credit risk of lending to commercial banks.[4]

When there is an increase in the TED spread, that can indicate a perception of an increase in the potential for default on the loans. When the spread appears to be decreasing, this can be an indicator that the time to borrow is very good and lenders can anticipate a relatively low number of defaults.[5]

References

  1. Financial Crisis Buzzwords: TED Spread. Time Magazine.
  2. What is a TED Spread?. WiseGEEK.
  3. Financials and TED Spread Could Signal a Bottom for Corporate Profit Declines. Seeking Alpha.
  4. Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong. DELong.
  5. What is a TED Spread?. WiseGEEK.