What Should You Know About Bond Ratings?

KALAMAZOO, Mich. - May 2, 2015 - PRLog -- When you purchase a corporate or municipal bond, you are lending money to a company or a state or local government. In return, you receive interest payments, and if you hold the bond until maturity, you’ll get your principal back, provided the bond does not default. So it’s important to understand the bond issuer’s creditworthiness — which means you should be familiar with bond ratings.

What is a bond rating?
Essentially, a bond rating is a “grade” that evaluates a bond issuer’s financial strength and its ability to repay principal and interest in a timely fashion.

Who issues these ratings?
Private independent rating agencies – such as Standard & Poor’s, Moody’s and Fitch – issue bond ratings. These rating agencies use various combinations of upper- and lower-case letters when publishing their grades. For example, Standard & Poor’s assigns a rating of “AAA” to bond issuers that show the greatest ability to meet their financial commitments, while Moody’s top grade is “Aaa.”

What is an “investment grade” bond?
An “investment grade” bond is one considered to carry a relatively low risk of default when compared to non-investment grade or “high-yield” bonds. Investment grade bonds are rated “BBB” and above by Standard & Poor’s and “Baa” and higher by Moody’s.

What is the relationship between a bond’s rating and its yield?
Generally speaking, the higher the bond’s rating, the lower its yield (rate of return). Bonds with the lowest ratings – sometimes called “high-yield” or “junk bonds” – offer higher yields, but also are at greater risk of default and subject to greater potential price swings.

What causes credit ratings to change?
Specific factors – such as new competition, new technologies or a shift in consumer preferences – may affect a particular company and lead to a revision of its bond rating. Ratings on municipal bonds may change due to factors including population shifts, rising or falling incomes of taxpayers, or other events that affect a state or local government’s tax receipts and ability to repay debts.

An Edward Jones financial advisor can provide you with more information on bond ratings and what they may mean to your investment choices.

Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.