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Bond Ratings

When you're in school, your performance is constantly being rated. If you do poorly, your teacher/professor will likely give you a lower grade for the class. If you do well, you'll probably receive a higher grade. This rating system is also used for bonds.

Investors who buy and sell bonds issued by corporations want to make sure that the company is doing well enough to pay them a consistent interest. They also want to make sure they'll receive their full investment back when the bond matures. That's why corporate bonds are given a rating.

There are two different services that rate bonds, Moody's and Standard and Poor's. For the most part, the ratings are the same but they're just given different letter codes. For example, Standard and Poor's rates AAA as the best and C as the lowest while Moody's rate bonds from Aaa being the highest to D being the lowest.Companies generally don't tell investors what their bonds are rated, especially if the company isn't performing well. The responsibility to research it is left up to the investor. You can find out information on debt issues from either Moody's or Standard and Poor's. However, once you find out the bond rating, you also have to understand it so we'll go over what they mean.

Investment Grade BondsInvestment grade bonds are those ranked higher than a Baa (Moody's) or BBB (Standard and Poor's) and are what is considered a high-quality bond. These bonds typically have the smallest amount of risk because the company is in good financial conditions. However, because there's less risk involved with these bonds, their yields (interest) are also slightly lower.Intermediate Grade BondsIntermediate grade bonds are generally bonds of companies that are in fair condition now but might not be in the future. These bonds are considered to have decent short-term security but more risk as the bond matures. Because there is more risk associated with these bonds, the issuer pays a higher interest rate. These bonds carry ratings of B, Ba (Moody's), or BB (Standard and Poor's).Junk BondsAs their name suggests, these bonds are the lowest rated bonds available and carry a rating of Caa/CCC or lower. The two services give these ratings to companies that they feel are in danger of defaulting. These bonds are considered highly speculative because even the short-term future of the company is unclear. The yields junk bonds pay are high for corporate bonds but, unless you're a bond professional, I urge you to choose another investment because of the risk associated with them.If the name "junk bond" rings a bell, it's probably because you remember the 1980's. In the 1980's, junk bonds were making a lot of people on Wall Street very rich. During that decade, there were a lot of large mergers and acquisitions. In order to finance these large expenses, the companies would float junk bonds to the public. Investors kept buying these low-quality bonds because the interest they were paying was so high.Corporate bonds might be an investment vehicle that interests you. The big disadvantage is that you often need a large initial investment to buy them individually. One nice alternative is to invest in a corporate bond mutual fund. Not only do they provide the higher yields that corporate bonds offer over treasury bonds, they also limit the individual risks by diversifying. You can learn more about them from one of the various fund families.

 

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