Types of Bonds

High-Yield Corporate Bonds

There are two categories of corporate bonds for investors--investment-grade corporate bonds and speculative-grade (also known as high-yield or the investor might hear the word “junk”).

Speculative-grade bonds are issued by corporations that are perceived to have a lower level of credit quality compared to more highly rated, investment-grade, corporate issues. Speculative-grade refers to the fact that originally banks were not allowed to invest in bonds beyond the four investment grade ratings because the bonds were too speculative, too risky. The speculative-grade category has six levels of ratings.

High-yield bonds are issued by organizations that do not qualify for “investment-grade” ratings by one of the leading credit rating agencies—Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings. Credit rating agencies evaluate issuers and assign ratings based on their opinions of the issuer’s ability to pay interest and principal as scheduled. Those issuers with a greater risk of default—not paying interest or principal in a timely manner—are rated below investment grade. These issuers must pay a higher interest rate to attract investors to buy their bonds and to compensate them for the risks associated with investing in organisations of lower credit quality.

Organisations that issue high-yield debt include many different types of corporations; newer companies; companies in particularly difficult economic sectors; companies engaged in financing leveraged buyouts; small companies undergoing a buyout, merger or restructuring; “fallen angels”, which are corporations which formerly had investment grade ratings but fell on hard times and “rising stars” which are emerging or start-up companies that have not yet achieved the operational history, the size or the capital strength required to receive an investment-grade rating, but turn to the bond market to obtain seed capital. Note that credit agencies’ ratings are reviewed periodically and may be upgraded or downgraded. Sometimes in this area of the corporate bond market, the rating agencies disagree on the rating, which results in a “split rating.” 

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