What is an investment grade bond? These are bonds whose credit rating is above investment grade, which means that they will generally provide a high level of income. They are rated by the major rating agencies, such as Standard & Poor’s and Moody’s Investors Service. But keep in mind that these ratings are only the opinion of the agency, and do not guarantee the quality of the bond, or even a recommendation to buy or sell.
The first half of 2016 witnessed 26 “fallen angels” worldwide, with financial institutions, mining and commodities companies, and oil & gas concerns leading the list. Almost half of these companies were based in the U.S., and many are start-up companies that do not yet have the operational history and balance sheet required to obtain an investment grade rating. This makes it important for investors to carefully consider the company’s business plan and overall financial health before investing in these securities.
The key difference between investment grade and non-investment grade bonds is the credit risk. Investment grade bonds have a lower credit risk than non-investment grade bonds. This means that investors are willing to accept lower yields in exchange for the low default risk. Investment grade bonds are considered to be safe for investors, and their yields are lower than their non-investment-grade counterparts. They also have lower interest rates than non-investment-grade bonds.
Investing in non-investment-grade debt requires a higher interest rate and investor-friendly structural features to compensate for their risk. These factors make it more difficult for average investors to invest in non-investment grade bonds, so it is highly recommended to stick to investing in investment grade bonds through mutual funds, index funds, and exchange-traded funds. It takes expertise to navigate the bond market and make good investments in individual investment grade bonds.
Investment grade bonds are generally rated Baa3/BBB or higher, and have a low default risk. However, high-yield bonds are considered riskier. They have higher volatility and liquidity risks and investors may not get their money back. It is important to note that rating agencies can change their ratings on an issuer at any time, so it is important to check the rating regularly. If you intend to sell your bond before its maturity date, the rating will affect the price you receive.
During the underwriting process, bond terms are negotiated. Issuers can often agree to call protection terms for half the bond’s life, so a 10-year paper cannot be called for five years. An eight-year bond, by contrast, can’t be called for four years. Call premiums are typically 50% of the coupon and are negotiated during the underwriting process. If the call protection term is not sufficient, investors may opt to purchase a floating-rate bond with a longer term.