Factors Affecting Credit (Yield) Spreads
Foreign Exchange Activity Department
Assets and Liabilities Unit
August 2005
Yehiel Rehavi, Asher Weingarten

The full article, in PDF file -

The Government of Israel and Israeli corporations raise capital abroad in a number of ways; one of them being the issue of foreign currency tradable bonds abroad. Interest rates for new bond issues are determined relative to that on risk-free bonds which serve as a benchmark, and the credit (yield) spread of an issue above the prevalent risk-free bond rate reflects an issue's creditworthiness. Changes in the spread of Israeli tradable bonds serve as an index of the perception of Israel's risk in the eyes of foreign investors - who hold the majority of these bonds.
This paper discusses the factors affecting USD credit spreads in general and those affecting Israeli government USD issues. In this context, the effect, on the spread, of Israeli resident holdings of Israeli government USD tradable bonds is examined. In addition, a comparison of credit spreads is made between bonds in various (investment grade) credit rating groups and between bonds of differing term structures. This study focuses on long-range trends in a historical perspective.
Credit spreads (in general and for Israeli government tradable issues) and credit spread changes are affected by the following factors: risk-free bond yields, global financial crises, bond term structure, issuer specific risk and (for Israeli issues) Israeli resident holdings of Israeli USD issues. Israeli residents who hold Israeli bonds traded abroad contribute to the lowering of these bond yields.
This paper concludes that a great part of the changes in Israeli government USD bond credit spreads are the result of exogenous factors. Further research may perhaps lead to a similar conclusion, regarding other investment grade sovereign issuers.