Types of Bonds
High-Yield Corporate Bonds
How Do Credit Ratings Affect Yield?
The leading rating agencies assess most issuers of corporate bonds as to their ability and willingness to pay interest and repay principal as scheduled. These agencies use quantitative tools and qualitative judgments to evaluate the creditworthiness of an issuer and have developed a grading system from which they assign credit ratings to these issuers. Usually, only bonds issued by the largest and strongest companies qualify for the prized “investment-grade” ratings, which indicate outstanding relative credit. The highest-quality rating is triple-A. The rating levels descend to triple-C as the possibility of default increases and finally to D, or default. Bonds considered to carry minimal likelihood of default are “investment grade” and are rated Baa3 or higher by Moody’s, or BBB- or higher by Standard & Poor’s and Fitch Ratings. Those companies rated below Baa3 or below BBB- are considered “speculative grade.” They have a higher risk of default and are classified as high-yield bonds, as are some types of nonrated bonds.
Bond Credit Quality Ratings by Rating Agencies
|Credit Quality||Moody's*||Standard & Poors**||Fitch Ratings**|
|Highest-quality (highest ability to repay debt)||Aaa||AAA||AAA|
|High quality (very strong ability to repay debt)||Aa||AA||AA|
|Upper medium grade (strong ability to repay)||A||A||A|
|Medium grade ability to repay; not investment grade||Baa||BBB||BBB|
|Lower medium grade (somewhat speculative, risk exposure)||Ba||BB||BB|
|Low grade (speculative; risk exposure)||B||B||B|
|Poor quality (may default)||Caa||CCC||CCC|
|No interest being paid or bankruptcy petition filed||C||D||D|
* The ratings from Aa to Ca by Moody’s may be modified by the addition of a 1, 2 or 3 to show relative standing within the category.
** The ratings from AA to CC by Standard & Poor’s and Fitch Ratings may be modified by the addition of a plus or minus sign to show relative standing within the category.
To entice investors and to compensate them for the attendant risks, issuers with lower-rated credits must pay a higher rate of interest than companies whose bonds are given an investment-grade rating. This in turn generates a higher “yield” for investors. For example, suppose a company that qualifies for the highest rating (AAA/Aaa) issues a 10-year bond with a yield of 6%. To compete for capital, a company rated single-B may need to offer a yield of 9% to 11%.