2.1. Bond Ratings

Before a bond is issued, it is rated according to its creditworthiness. How creditworthy a bond is depends mostly on how creditworthy the issuing company is, based on an assessment of the likelihood that the issuer may default on its debt payments. Rating agencies such as Standard & Poor’s, Moody’s Investors Services, and Fitch Ratings are hired by the issuing company to assess the financial strength of the company. Their evaluation of the company’s ability to pay a bond’s principal and interest in a timely fashion will determine the bond’s coupon rate. The higher the ratings service’s grade, the lower the perceived risk, and thus, the lower the coupon rate on the bonds.

Bond ratings are expressed as letters ranging from AAA to C. A “triple-A” rating is the most desirable, representing an investment-grade bond with minimal credit risk. To be considered investment grade, a corporate bond must be rated BBB- or better. BB+ or below is considered non-investment grade. These kinds of bonds are referred to as high-yield bonds, speculative bonds, or junk bonds. Each of the services uses the same basic grading system, with some variations in style. Here is a sampler:

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