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Bond Rating
Research on bonds fills volumes. Or these days, the hard drives
of web servers.
Nowhere else in the investing world can the interested investor
get more helpful information than that available from the
various bond rating agencies.
Standard & Poor's and Moody's are the most well known, but
there are many others. (DBRS in Canada and Fitch are only two
examples.) These agencies provide investors with thoroughly
researched ratings on the risks associated with buying a
particular company's (or government's) bond.
Stocks frequently get recommendations - (strong) buy, hold,
sell - from analysts. Bond ratings get assigned over 20
different possible designations, from AAA (Highest Grade) to C
(May Be In Default) or worse. And those designations are backed
by some of the most thorough historical and technical research
on the planet. The local geology of most cities is less well
understood than the financial condition of many companies.
Because of select fixed characteristics - unlike stocks, for
example, bonds always have an associated interest rate (which
is sometimes zero) and a set maturity date - bonds are more
predictable. Those two factors alone makes possible the use of
an array of mathematical tools to provide predictions of future
yields and price with a confidence unmatched by any other
investment.
Standard and Poor's rates around 2,000 domestic and foreign
companies, 8,000 government entities, and 1,300 commercial
paper-issuing entities. Moody's rates over 19,000 long-term
debt issues, 28,000 municipals, and 2,000 commercial paper
issuers.
Some of the more common and useful ratings are explained
below.
Moody's S&P's
Aaa (AAA)
Bonds rated Aaa are judged to be of the best quality, carrying
the smallest degree of investment risk. Interest payments are
typically protected by a large or exceptionally stable margin
and the principal is believed secure.
Baa (BBB)
Baa rated bonds are considered medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest
payments and principal security are thought adequate at the
time the rating is made, but might prove unreliable over time.
Such bonds are less secure and have some speculative
characteristics too.
B (B)
Bonds with B rating are generally considered speculative.
Interest and principal payments are not assured.
A Moody rating may have digits following the letters, for
example, A2 or Aa3, indicating finer grading. S&P attaches
plus signs to some for the same purpose.
Agencies make clear that credit ratings don't represent
recommendations one way or the other, but taking them into
account is common practice. But remember, bond ratings for a
particular issue can change over time, as the issuer's fortunes
wax or wane.
In general, bonds with higher ratings tend to have lower
yields. Higher risk bonds offer higher yields and/or lower
prices in order to attract investors. These so-called high
yield or 'junk bonds' (below Baa/BBB) aren't necessarily bad
investments.
In 1991, those who gambled on lower rated bonds reaped the
highest total returns: an average 34.5 percent. One year later,
in a less outstanding year for bonds, junk debt took second
place in the race for high returns, 18.2 percent compared to
22.4 percent return on convertible debt. The example remains
relevant today.
Even at the lower figure, they outpaced many stocks. Of course,
that's an average and when considering a purchase investors
have to look not only at potential returns but expected default
rates.
Statistics making that estimate more rational are available
from dozens of Internet sites that report on bonds. The prudent
investor will take advantage of that information when making an
investment decision.
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