A bond is a debt instrument that companies or governments use to finance their operations. Investors usually prefer investing in bonds due to their higher security and more stable nature. However, some bonds also come with higher risks but fetch more rewards as well. Investors can differentiate between various types of bonds based on the bond’s rating. Bonds may either come as high-yield or investment grade.
Rating agencies provide various levels of credit rating for bonds. The highest rating that these agencies can give is the AAA rating, which shows a highly stable bond. These are bonds that have the lowest default risks. Similarly, AA, A, and BBB credit ratings are also good ratings. On the other hand, a D rating represents the lowest creditworthiness. Some other low credit ratings include BB, B, CCC, CC, and C credit ratings.
What are High Yield Bonds?
High-yield bonds, also known as junk bonds, are bonds with higher interest payments from the issuer. However, these bonds have a low credit rating compared to investment-grade bonds. High-yield bonds come with a higher default risk for investors. However, they bear higher interest rates that can compensate investors for those risks.
On the credit rating scale, high-yield bonds come with a credit rating of BB down to a D credit rating. High-yield bonds have a lower credit quality compared to investment-grade bonds. Not only do they come with higher default risks, but also with delayed payments and interest payment defaults. For investors, the decision to choose these bonds ultimately comes down to the higher returns they can get from it.
What are Investment Grade Bonds?
Investment-grade bonds are the opposite of high-yield bonds. These bonds come with lower risks to the lender. However, they don’t come with the same returns as high-yield bonds. Therefore, these bonds represent a more stable and steady investment for investors. Usually, risk-averse investors prefer investing in these bonds instead of high-yield bonds.
On the credit rating scale, investment-grade bonds come with a credit rating of AAA up to a BB credit rating. Investment-grade bonds are of higher quality compared to higher-yield bonds. Therefore, investors can expect timely interest payments and, sometimes, no defaults at all. For investors, investment-grade bonds are a much safer bet when it comes to their investments.
What are the differences between High Yield and Investment Grade Bonds?
High-yield and investment-grade bonds are different from each other based on several characteristics. These are as below.
Credit rating
As mentioned, high-yield bonds come with a credit rating of BBB and lower. On the other hand, investment-grade bonds come with a credit rating of BB or higher.
Risks
High-yield bonds carry higher default risk. Therefore, investors may get delayed payments or even defaults. Investment-grade bonds come with lower default risks.
Source
High-yield bonds usually come from insolvent or small size companies. Investment-grade bonds usually come from government bodies or highly solvent companies.
Returns
Investors can expect higher returns on high-yield bonds due to the associated risks. On the other hand, investment-grade bonds carry comparatively lower interest rates.
Maturity
High-yield bonds usually have shorter maturity periods. On the other hand, investment-grade bonds come with longer maturity terms.
Conclusion
Based on their credit ratings, bonds may come in high-yield or investment-grade varieties. High-yield bonds come with higher default risks but also carry higher returns. Similarly, they have a credit rating of BBB or lower. Investment-grade bonds have lower default risks and lower returns. They have a credit rating of BB or higher.
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