Under what conditions would the traditional yield spread be close to the static spread?

What will be an ideal response?

There are three conditions that will cause the traditional yield spread to be closer to the static spread: a short maturity, a flat yield curve, and bullet payment at maturity for a corporate bond. More details are given below.

Exhibit 18-3 shows the static spread and the traditional yield spread for bonds with various maturities and prices, assuming the Treasury spot rates shown in Exhibit 18-1 . Notice that the shorter the maturity of the bond, the less the static spread will differ from the traditional yield spread. The magnitude of the difference between the traditional yield spread and the static spread also depends on the shape of the yield curve. The steeper the yield curve, the more the difference for a given coupon and maturity. Another reason for the small differences in Exhibit 18-3 is that the corporate bond makes a bullet payment at maturity. The difference between the traditional yield spread and the static spread will be considerably greater for sinking fund bonds and mortgage-backed securities in a steep yield curve environment.