In past explainers, we talked about sovereign bonds and corporate bonds. We even looked at factors to consider before investing in sovereign bonds and created a checklist for corporate bonds.
Have you ever wondered how the market determines the appropriate yields on these securities? Comparing the fundamentals of two or more issuers is just one step in the process. We first need to compare these issuers to their corresponding risk-free rate.
Peso government securities and US Treasuries – what do they have in common? Both are fixed-income securities issued by governments in their local currencies. Both are also considered risk-free rates.
Are they truly risk-free? No investment comes without any level of risk. Even governments can default on their debt.
But since the Philippine and US governments hold authority over the Philippine peso and US dollar, respectively, it is highly unlikely that they will default on debt denominated in their local currencies. Therefore, it is widely understood that these fixed income securities carry the lowest risk in their respective markets.
The risk-free rate serves as the minimum return for any investor. Every other investment must pay a higher rate of return.
A peso corporate bond should offer a higher yield than a peso government security of the same tenor. Likewise, all US dollar-denominated sovereign and corporate bonds should offer higher yields than a US Treasury also of the same tenor. Otherwise, it does not make sense for an investor to take on more risk.
The Philippine government issues its own Republic of the Philippines (ROP) foreign-currency sovereign bonds. Unlike peso government securities, these bonds are not as low risk or risk-free. The Philippines does not naturally print the currencies needed to repay these bonds. Therefore, the government is exposed to foreign exchange risk.
One example is ROP 4.25 31 – a US dollar-denominated sovereign bond that will mature on July 27, 2031. As of this writing, that date is a little less than 5 years from now. The bond has an indicative offer yield-to-maturity of 4.823% per annum.
In contrast, the yield on a reference 5-year US Treasury is 4.352% per annum. Naturally, the ROP 4.25 31 bond offers a higher yield than the risk-free rate.
The difference of roughly 47-basis points (bps) between the two yields is known as a credit spread.
A credit spread is the additional yield that sovereign and corporate bonds pay over the risk-free rate. It is meant to compensate investors for the added risk that sovereign and corporate issuers carry.
Note that credit spreads are never a single static number. They are dynamic values that move depending on many factors affecting the issuer, such as default risk, creditworthiness, financial condition, liquidity, and prevailing market conditions.
When risk sentiment improves, credit spreads usually tighten. When risk sentiment worsens, credit spreads can also widen.
Similar issuers can have completely different credit spreads because of various circumstances. Consider the same ROP 4.25 31 example versus an Indonesian US dollar sovereign bond, INDON 31NEW.
Indicative pricing as of August 11, 2026
Both issuers are major Southeast Asian economies. Indonesia is much larger than the Philippines, but bigger does not always mean better. Indonesia has its own political and economic issues, and some global investors might have concerns about how the Indonesian government plans to address them given the country’s sheer size.
In contrast, the Philippines used to have much wider credit spreads not so long ago. Back in 2022, the Philippine government issued a 5-year ROP 27 at a credit spread of 90 bps over the comparable 5-year US Treasury. Despite persistent challenges, the credit spread on 5-year Philippine US dollar sovereign bonds has tightened to just below 50 bps as of this writing.
In summary, a bond’s yield equals the risk-free rate plus the issuer’s credit spread.
Both components can move independently. A risk-free rate could decline as inflation expectations fall, and central banks cut interest rates. However, mounting issuer risks may cause the credit spread to widen, keeping the bond’s all-in yield elevated.
Before investing in sovereign and corporate bonds, it is important to consider where risk-free rates and credit spreads are headed and whether the additional return per unit of risk makes sense to you as an investor.
EARL ANDREW “EA” AGUIRRE is the Head of the Investment Counselor Department under the Financial Markets Sector of Metrobank. He has more than a decade of experience in foreign exchange, fixed income securities, and derivatives sales. He has a Master’s in Business Administration from the Ateneo Graduate School of Business. His interests include regularly traveling to Japan and learning its language and culture.
RANS SULAY is a Metrobank intern in the Financial Markets Sector and a recent graduate of Ateneo de Manila University with a degree in BS Management. Outside of work, he enjoys reading, exercising, and playing video games.
