Chartered Financial Analyst (CFA) Practice Exam Level 2

What does the TED spread specifically measure?

1. The difference between 3-month LIBOR and 3-month T-bill rates

2. The risk in the stock market

3. The volatility of interest rates

4. The spread between corporate and government bond yields

The correct answer is: The difference between 3-month LIBOR and 3-month T-bill rates

The TED spread specifically measures the difference between the 3-month LIBOR (London Interbank Offered Rate) and the 3-month T-bill (Treasury bill) rates. It serves as an indicator of the credit risk perceived by investors in the banking sector compared to the risk-free rate represented by U.S. Treasury bills. A widening TED spread suggests increasing risk associated with interbank lending, as financial institutions may charge higher rates to lend money to each other. Conversely, a narrowing spread typically implies lower perceived credit risk and more confidence in the banking sector. The other options relate to different financial concepts. The risk in the stock market, while relevant, is not captured by the TED spread; it is more associated with market volatility and investor sentiment. Similarly, the volatility of interest rates is a broader term and not specifically tied to the relationship between LIBOR and T-bill rates. Lastly, the spread between corporate and government bond yields refers to credit spreads, which are concerned with the risk premium investors require for holding corporate debt over risk-free government securities. Thus, the TED spread is distinctly focused on the banking sector's intercredit market and its implications for credit risk.