A non-investment grade bond, also known as a speculative bond, a high yield bond, an unsecured debenture, or a junk bond, is a bond that is regarded as a low-quality investment due to the possibility of default by the issuer. To compensate for the additional risk, non-investment grade bonds have higher yields than investment grade bonds.
What is the definition of an investment-grade bond?
Bonds rated Baa (by Moody’s) or BBB (by S&P and Fitch) or above are thought to have a lesser risk of default and obtain higher ratings from credit rating organizations. The yields on these bonds are often lower than those on less creditworthy bonds.
What are some investment-grade ratings?
Debt (such as a bond or a loan) is considered investment grade if Standard & Poor’s has awarded it a credit rating of BBB- or higher. Moody’s assigns a rating of Baa3 or above.
What is the significance of understanding the distinction between investment grade and non-investment grade bonds?
Information on the global default rates of certain bond ratings can be found in S&P Global’s 2018 Annual Global Corporate Default and Rating Transition Study.
When compared to non-investment grade bonds, investment-grade bonds have a low default rate. For example, according to S&P Global, the highest one-year default rates for AAA, AA, A, and BBB-rated bonds (investment-grade bonds) were 0%, 0.38, 0.39, and 1.02 percent, respectively. In comparison, the maximum one-year default rates for BB, B, and CCC/C-rated bonds (non-investment-grade bonds) are 4.22 percent, 13.84 percent, and 49.28 percent, respectively, for BB, B, and CCC/C-rated bonds (non-investment-grade bonds). As a result of their historically low default rates, institutional investors often stick to a strategy of only investing in investment-grade bonds.
Example of Investment-Grade Bonds
An investor wants to put money into a floating rate fund. His criterion is that the fund’s bonds must contain a majority of investment-grade bonds (>50%). The fund adheres to the S&P credit rating methodology and has the following credit allocation:
Does the floating rate fund meet the requirement of having a majority of investment-grade bonds?
Bonds rated BBB- or higher in S&P’s credit rating system are considered investment-grade. As a result, the floating rate fund mentioned above has 62 percent of its assets in investment-grade bonds. As a result, the floating rate fund meets the investor’s requirement.
Implications of Credit Rating on Bond Yields
The lower the bond yield, the higher the bond rating. The return on a bond is referred to as bond yield. As a result, investment-grade bonds will always pay a lower interest rate than non-investment-grade bonds. Because investors expect a greater yield to compensate for the higher credit risk associated with holding non-investment-grade bonds, this is the case.
For example, an investor may expect a yield of 3% for a 10-year bond rated AAA (investment-grade) due to the bond’s relatively low credit risk, but a yield of 7% for a 10-year bond rated B (non-investment-grade) due to the instrument’s higher implied credit risk.
What are the lowest-rated bonds, or ones that aren’t investment-grade?
Standard & Poor’s and Moody’s employ separate designations to indicate a bond’s credit quality rating, which consist of the upper- and lower-case letters “A” and “B.” Investment grade is defined as “AAA” and “AA” (high credit quality) and “A” and “BBB” (medium credit quality). Bonds with credit ratings below these categories (“BB,” “B,” “CCC,” and so on) are referred to as “junk bonds” because they have a low credit grade.
What is the distinction between investment grade and non-investment grade securities?
- Bonds rated Ba1/BB+ and lower are classified as high-yield (also known as “non-investment-grade” or “junk” bonds).
To invest in high-yield bonds, you must have a high risk tolerance. Ratings agencies can lower or raise a company’s rating because the financial health of an issuer might vary, regardless of whether the issuer is a corporation or a municipality. It’s critical to keep an eye on a bond’s rating on a frequent basis. Any downgrades or upgrades in a bond’s rating can affect the price others are prepared to pay for it if it is sold before it reaches maturity.
What kind of credit rating would junk bonds get?
- Because junk bonds have a lower credit rating than investment-grade bonds, they must provide higher interest rates to entice investors.
- Standard & Poor’s rates junk bonds as BB or lower, whereas Moody’s rates them as Ba or lower.
- The bond issuer’s rating shows the likelihood of default on the debt.
- If you want to invest in junk bonds but don’t want to pick them out yourself, a high-yield bond fund is a good option.
Which of the following credit ratings is not considered investment grade?
, which are securities issued by a publicly listed corporation or municipality that have been downgraded in ratings or have experienced some other bad occurrence (so-called “distressed”). Debt that was originally issued below investment grade might also be classified as high yield. High yield bonds have grown more popular in investor portfolios since the 1980s as a source of additional yield over investment-grade bonds.
Is it dangerous to invest in non-investment grade bonds?
A junk bond is a debt that has received a poor credit rating from a rating agency and is considered below investment grade. As a result, these bonds are riskier because the likelihood of the issuer defaulting or experiencing a credit event is greater.
How frequently do CCC bonds fail?
- In the last 12 months, only 16 percent of ‘CCC’ rated issuers defaulted, compared to a historical average of 35 percent.
- The pandemic’s significant impact resulted in downgrades of companies with substantially stronger businesses than those degraded prior to the epidemic, implying that their recovery chances may be better once limitations are eased.
- Upgrades out of the ‘CCC’ category have traditionally taken longer in the years following a significant crisis, as the long-term viability of credit metrics improvement must be demonstrated.
- If growth and deleveraging prospects slow, and crucial lifelines such as exceptional policy support and accommodating debt capital markets—essential for the poorest companies—disappear, default rates could rise in 2022.
Why are non-investment grade bonds’ direct expenses so much higher than investment grade bonds?
Why are noninvestment-grade bonds’ direct expenses so much higher than investment-grade bonds? From the standpoint of an investment bank, they are riskier and more difficult to market. Because comparable bond yields are frequently readily available, effectively pricing a bond offering is significantly easier.