What is the formula for excess return on a bond?

The formula for excess return on a bond that is correctly identified is based on the relationship between the bond's spread, the change in that spread, and the time involved, adjusted for spread duration. This helps to quantify the impacts of both the inherent yield spread (the additional yield over a benchmark) and the potential changes to that spread over a given time period.

The bond's excess return is measured as the spread times the time period, providing an initial expectation of returns derived from the yield advantage over the risk-free rate. However, this needs to be adjusted by how sensitive the bond's value is to changes in credit spreads, which is where the term involving the change in spread and spread duration comes into play. Spread duration indicates how much the price of a bond will change in response to changes in its yield spread and allows for an adjustment for these fluctuations.

Therefore, the formula accurately incorporates both the immediate yield spread benefit and the anticipated changes in that spread, reflecting a more complete picture of expected returns from holding the bond. This integrated approach is crucial for assessing the bond's potential performance relative to market conditions and credit risk.

Other potential formulas do not encompass this comprehensive interactive effect between spread, time, and changing market conditions properly, making them less applicable for