![]() In the Treasury market, on the other hand, there are no differences in ratings or industry classifications to contend with, as there is only one issuer. For example, monthly and quarterly swings in oil and gas prices get reflected in the prices and yields of energy bonds, but not in their ratings, which are intended to be longer-term assessments of default risk. Industry classification is another important factor. ![]() Neither do all bonds of a given rating and maturity trade at or very close to the median yield. Note that rating differences do not explain all bond-to-bond yield differences within the corporate universe. An actively managed corporate bond portfolio may, for example, reallocate some capital from A issues to BBB issues at a time when the yield differential between those categories is unusually large by historical standards and, in the portfolio manager’s judgment, likely to decrease in the near term as the economic outlook improves, reducing investors’ concerns about default risk. Yield differentials among the rating categories vary over time, according to investors’ prevailing level of concern about default and price risk. The table below shows median yields on bonds maturing in ten years, sorted by Composite Rating, the average of the ratings of the major credit rating agencies, as of June 30, 2022. You also need to take into account price risk lower-rated bonds generally fall more sharply when recession fears escalate than higher-rated bonds with similar maturities, even in the absence of any defaults. Your choice of which bond to buy involves a tradeoff between default risk and yield. The lower the rating, the higher is the rating agency’s estimate of the bond’s default risk. The medium- to high-quality issues discussed in this article carry ratings in a range from Aaa to Baa (Moody’s) and AAA to BBB (Standard & Poor’s). When buying corporate bonds, however, you also have to take into account variation in ratings. Those considerations also apply to corporate bonds bonds that have smaller amounts outstanding are generally less liquid than larger issues. When deciding which Treasury bond to buy, you can focus on which maturity date best matches your investment horizon, your outlook for interest rates (longer-maturity bonds generally fall more than shorter-maturity bonds when interest rates rise), and minor differences in marketability between the most actively trading bond of a given maturity and off-the-run issues with similar maturities. Those ratings apply to all Treasury issues. The other most prominent credit rating firm, Standard & Poor’s, rates the United States slightly lower, at AA+ on its scale. Treasury bonds are customarily seen as having a vanishingly small probability of default, they carry Moody’s highest credit rating, Aaa. Credit Ratings As An Investment Considerationīecause U.S. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz. With inflation running high at 4.9%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. The market awards investors a yield premium as an offset to this lesser marketability vis-à-vis Treasurys. In contrast, many corporate bonds go days at a time without trading and the quotes on them show wide differences between the bid and asked prices. The price at which the bond is offered will not be much above the price at which you can sell the bond. Bid and asked quotes for any Treasury bond you wish to buy or sell are readily available. Its issues change hands every day the market is open. ![]() Treasury obligations is widely regarded as the world’s deepest. In addition to rewarding you for taking default risk, the market compensates you for the comparative illiquidity of your corporate issue. The default-related portion of a bond’s spread-versus-Treasurys is estimated as Probability of Default x (1 – Expected Percentage Recovery of Principal). Typically, bondholders do not lose their entire principal when an issue defaults. The default risk for which the market compensates you is a function not only of the probability of default, but of the expected loss in the event of default. As small as the likelihood is that you will buy an investment grade corporate bond and fail to receive scheduled interest and principal payments any time soon, the market awards you a yield premium over comparable-maturity Treasurys for taking that risk. Over a 20-year period, the incidence increased to 5.3% or about one in 20. Moody’s Investors Service reports that over the period 1970-2022 the incidence of default within one year for medium- to high-quality bond issuers such as those discussed in this article, was 0.1% or one in 1,000. Defaults can and do occur, however, within the universe of corporate bonds.
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