Credit Curves and the Term Structure of Spreads

A company's 1-year CDS spread and its 10-year CDS spread are almost never the same number. Plot spread against maturity for every tenor traded on a single name and you get a credit curve — and just like a government bond yield curve, its shape carries information the level alone doesn't.

Why the curve slopes at all

For a healthy company, default risk usually rises the further out you look — more can go wrong over ten years than over one — so credit curves are normally upward sloping: short-dated protection is cheap, long-dated protection is expensive. This mirrors the same level/slope/curvature decomposition used to read a government yield curve, just applied to default risk instead of interest-rate risk.

Although this explorer is built around rate curves, the same three moves apply to a credit curve: drag the level control up and you're pricing a company that's simply riskier at every horizon; drag the slope toward inversion and you're pricing a company whose danger is concentrated in the near term rather than spread evenly across the years.

A distressed company flips this. If a firm might default within the next year, the market prices near-term protection expensively — it needs to be compensated for a risk that could crystallize any moment — while longer-dated protection is comparatively cheaper, because conditional on surviving the crisis, the firm's longer-run outlook may not be much worse than average. The curve inverts: short spreads sit above long spreads.

Worked example

A retailer's CDS curve shows: 1-year spread 800 bps, 5-year spread 550 bps, 10-year spread 500 bps.

1. Shape. Spreads fall as maturity extends — this curve is inverted.
2. Reading it. The market is pricing a real chance this company doesn't survive the next twelve months (800 bps is roughly an 8% annualized cost just to insure one year of risk). If it survives that window, the 5- and 10-year spreads say the market expects a meaningfully less dangerous path afterward.
3. Contrast. A stable investment-grade industrial might instead show 1-year at 40 bps, 5-year at 75 bps, 10-year at 95 bps — a normal, gently rising curve, consistent with steady, low, slowly-accumulating risk rather than an acute near-term threat.

What this means in practice

Traders bootstrap a full credit curve — one default intensity per tenor — from the handful of CDS or bond spreads that actually trade, then use it to price and hedge every other maturity on that name, even ones with no direct quote. The curve's shape is also a standalone signal: distressed-debt investors and credit analysts watch for inversion as one of the more reliable early markers of acute stress, often showing up before rating agencies act and before equity markets fully price it in.