Investment-Grade Bonds: Head and Shoulders Above the Rest

Many investors choose to invest in investment grade bonds because of the safety that they provide. Here are the basics of investment grade bonds.

What Is Investment Grade?

The term "investment grade bond" essentially means that the bond is a very safe investment. As an investor, you should feel very little apprehension about investing your money into an investment grade bond. Investment grade bonds are a class of bonds that represent the best that the industry has to offer. 

How a Bond Is Determined to Be Investment Grade

In order to determine which bonds are investment grade, a bond rating system is utilized. Each bond that is issued in the market will be rated based on certain financial criteria. Financial institutions such as Standard & Poor's, Moody's, and others offer bond ratings. Each company uses a slightly different rating system for bonds. The highest rating that a bond can have is "AAA." When a bond receives this rating, it means that the company that issued the bond has nearly perfect credit. The bond scale is based on a series of letter grades. As you go lower on the scale, you will find companies that have questionable credit. The scale goes all the way down to a "D." 

In order to be qualified as investment grade, a bond has to have a rating of at least BBB- on Standard & Poor's or at least Baa3 on Moody's.

Importance to Investors

Whether a bond is considered investment grade or not has significant importance to investors. When a bond is purchased by an investor, this is essentially like the investor lending money to the corporation or government. If the entity that issues the bond files for bankruptcy, they will not be able to continue their regular interest payments to the investors. The investors may be able to get their initial deposit back if the company that issued the bonds has enough assets to satisfy the debt. 

An investment grade bond represents a debt instrument that is attached to a relatively safe company to lend money to. If you are going to invest in a bond, you want to know that there is a high probability of collecting your interest payments and getting your initial deposit back. If you invest in a corporate bond that is rated below investment grade, you are taking a risk on whether or not you will be able to collect your interest payments. 

Junk Bonds

A bond that is rated as BB or below on Standard & Poor's or Ba3 on Moody's is considered a junk bond. Investors that choose to invest in bonds in this category do so because of the high interest rates that they can get. However, investing in this category of bonds can be a very big gamble. You may or may not be able to get your money out of them. 

Examples

Government bonds are the only type of bond that are not rated because they represent the safest form of investment that you could make. Government Sponsored Enterprises will typically have a AAA rating because of the government backing. Wal-Mart has bonds that are rated at a AA rating and Berkshire Hathaway has a rating of AA+.   


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