Initially, the TED spread was the difference between the interest rate for the three month U.S. Treasuries contract and three month Eurodollars contract as represented by the London Inter Bank Offered Rate (LIBOR). However, since the Chicago Mercantile exchange dropped the T-bill futures, the TED spread is now calculated as the difference between the T-bill interest rate and LIBOR. The TED spread is a measure of liquidity and shows the flow of dollars into and out of the United States. The TED spread can be used as an indicator of credit risk. This is because U.S. T-bills are considered risk free while the rate associated with the Eurodollar is thought to reflect the credit risk of corporate borrowers. As the TED spread increases, default risk is considered to be increasing, and investors will have a preference for safe investments. As the spread decreases, the risk of default is considered to be decreasing. The name originates from the initialism of "T-Bill" and "ED"— the ticker symbol for the Eurodollar futures contract. The size of the spread is usually denominated in basis points (bps), e.g. when T-Bills trade at 5.10% and ED trades at 5.50%, the TED spread is said to trade at 40bps. The value of the TED spread fluctuates over time but is often between 10 and 50 basis points (0.1% and 0.5%). A rising TED spread often foretells a downturn in the U.S. stock market as liquidity is withdrawn. During 2007, the credit crunch, which many believe was caused by the U.S. subprime mortgage securities meltdown, ballooned the TED spread to a region of 150-200bps.
