c
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c
In general, fixed-income securities are classified according to the length of time before maturity.
These are the three main categories:

cdebt securities maturing in less than one year.

 debt securities maturing in one to 10 years.
c debt securities maturing in more than 10 years.

Marketable securities from the U.S. government - known collectively as Treasuries - follow this
guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills).
Technically speaking, T-bills aren't bonds because of their short maturity. (You can read more
about T-bills in our þ
þ tutorial.) All debt issued by Uncle Sam is regarded as
extremely safe, as is the debt of any stable country. The debt of many developing countries,
however, does carry substantial risk. Like companies, countries can default on payments.

þ c
Municipal bonds, known as "munis", are the next progression in terms of risk. Cities don't go
bankrupt that often, but it can happen. The major advantage to munis is that the returns are free
from federal tax. Furthermore, local governments will sometimes make their debt non-taxable for
residents, thus making some municipal bonds completely tax free. Because of these tax savings,
the yield on a muni is usually lower than that of a taxable bond. Depending on your personal
situation, a muni can be a great investment on an after-tax basis.

c
A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility
as to how much debt they can issue: the limit is whatever the market will bear. Generally, a
short-term corporate bond is less than five years; intermediate is five to 12 years, and long term
is over 12 years.

Corporate bonds are characterized by higher yields because there is a higher risk of a company
defaulting than a government. The upside is that they can also be the most rewarding fixed-
income investments because of the risk the investor must take on. The company's credit quality
is very important: the higher the quality, the lower the interest rate the investor receives.

Other variations on corporate bonds include convertible bonds, which the holder can convert into
stock, and callable bonds, which allow the company to redeem an issue prior to maturity.

 c
This is a type of bond that makes no coupon payments but instead is issued at a considerable
discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and 10
years to maturity is trading at $600; you'd be paying $600 today for a bond that will be worth
$1,000 in 10 years.


Ä !"# ! $

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 hen any lending institution makes a loan to a consumer for an expensive purchase like a house
or a car, the institution evaluates the borrower's credit. Since the goal is for the institution to be
paid back in full with interest, the institution tries to make sure that the borrower is currently
financially able to meet the payment schedule and that the borrower has a track record for paying
back loans on time. In other words, the bank or other institution evaluates the credit risk of any
loan made to that borrower. Credit risk is a measure of the likelihood the borrower will default
on the loan, causing the lending institution to lose money.

Bond ratings are a gauge of the credit risk you take as a bond purchaser.  hen you buy bonds,
you are essentially making a loan to the issuer of the bonds. As an investor in bonds, your goal is
to get your money back with interest. If the government, municipality, or corporation that issued
your bond becomes insolvent and cannot pay what it owes to its creditors, you stand a chance of
losing all or part of your investment. Thus it's important that you have a means of determining
the credit risk associated with a particular bond issue before you buy.

Fortunately, as an investor you don't have to dig deeply into the financial records of
organizations issuing bonds to assess their credit risk. Just as there are companies that provide
banks and mortgage companies with credit reports on individual consumers, there are companies
that specialize in doing the research required to provide credit reports on bond issuers. These
companies investigate the financial condition of the issuers, their management practices, and
their strategic plans in light of current economic and political conditions. A bond rating
represents the sum of their findings.

The three major companies that rate bonds are Moody's Investors Service, Standard & Poor's,
and Fitch Ratings. Bonds are rated when they are first issued and when the circumstances of the
issuing organization change significantly. The conclusions of the three ratings companies are
often the same, but not always. Moody's, S&P, and Fitch have slightly different ways of notating
their ratings. All of them rate bonds on a scale from highest to lowest quality. In general a high
quality bond is one that has a low likelihood of default, but pays less interest than a low quality
bond. As an investor you get rewarded for accepting more risk if things go well.
The rating scales listed here are ordered from the highest to the lowest degree of safety. The
greatest credit risk is associated with the lowest rating. For example, an AAA or Aaa rating
indicates the safest possible investment grade bond with almost no chance of default. A rating of
B or B2 indicates a very speculative choice.  hen you get down to C and D ratings you are
looking at issuers already in default or looking like they're headed that way.

Moody's: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3,
Caa1, Caa2, Caa3, Ca, C

Standard & Poor's: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+,
B, B-, CCC+, CCC, CCC-, D

Fitch: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC,
DDD, DD, D

Bonds with BBB/Baa and above ratings are usually considered "investment grade." Bonds with
ratings of BB/Ba and below are considered "below investment grade" or "speculative" bonds.
These lower-ranked bonds are also called "junk" bonds, reflecting their high credit risk, or "high-
yield" bonds, reflecting their potential returns.

In investment, the "# assesses the credit worthiness of a corporation's or

government debt issues. It is analogous to credit ratings for individuals. The credit rating is a
financial indicator to potential investors of debt securities such as bonds. These are assigned by
credit rating agencies such as Moody's, Standard & Poor's, and Fitch Ratings to have letter
designations (such as AAA, B, CC) which represent the quality of a bond. Bond ratings below
BBB/Baa are considered to be not investment grade and are colloquially called junk bonds.

þ
 
  

         

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Credit rating agencies registered as such with the SEC are known as ³Nationally Recognized
Statistical Rating Organizations.´ The following firms are currently registered as NRSROs: A.M.
Best Company, Inc.; DBRS Ltd.; Egan-Jones Rating Company; Fitch, Inc.; Japan Credit Rating
Agency, Ltd.; LACE Financial Corp.; Moody¶s Investors Service, Inc.; Rating and Investment
Information, Inc.; Realpoint LLC; and Standard & Poor¶s Ratings Services. Under the Credit
Rating Agency Reform Act, an NRSRO may be registered with respect to up to five classes of
credit ratings: (1) financial institutions, brokers, or dealers; (2) insurance companies; (3)
corporate issuers; (4) issuers of asset-backed securities; and (5) issuers of government securities,
municipal securities, or securities issued by a foreign government.[1]

S&P, Moody's, and Fitch dominate the market with approximately 90-95 percent of world
market share.

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Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, with  R and NR as
withdrawn and not rated.[2] Standard & Poor's and Fitch assign bond credit ratings of AAA, AA,
A, BBB, BB, B, CCC, CC, C, D.

As of October 16, 2009, there were 4 companies rated AAA by S&P:[3]

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Moody's, S&P and Fitch will all also assign intermediate ratings at levels between AA and CCC
(e.g., BBB+, BBB and BBB-), and may also choose to offer guidance (termed a "credit watch")
as to whether it is likely to be upgraded (positive), downgraded (negative) or uncertain (neutral).
 


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A bond is considered # or  if its credit rating is BBB- or higher by Standard

& Poor's or Baa3 or higher by Moody's or BBB(low) or higher by DBRS. Generally they are
bonds that are judged by the rating agency as likely enough to meet payment obligations that
banks are allowed to invest in them.

Ratings play a critical role in determining how much companies and other entities that issue debt,
including sovereign governments, have to pay to access credit markets, i.e., the amount of
interest they pay on their issued debt. The threshold between investment-grade and speculative-
grade ratings has important market implications for issuers' borrowing costs.

Bonds that are not rated as investment-grade bonds are known as # $ bonds or more
derisively as junk bonds.

The risks associated with investment-grade bonds (or investment-grade corporate debt) are
considered noticeably higher than in the case of first-class government bonds. The difference
between rates for first-class government bonds and investment-grade bonds is called investment-
grade spread. It is an indicator for the market's belief in the stability of the economy. The higher
these investment-grade spreads (or risk premiums) are, the weaker the economy is considered.
Ë(
Until the early 1970s, bond credit ratings agencies were paid for their work by investors who
wanted impartial information on the credit worthiness of securities issuers and their particular
offerings. Starting in the early 1970s, the "Big Three" ratings agencies (S&P, Moody's, and
Fitch) began to receive payment for their work by the securities issuers for whom they issue
those ratings, which has led to charges that these ratings agencies can no longer always be
impartial when issuing ratings for those securities issuers. Securities issuers have been accused
of "shopping" for the best ratings from these three ratings agencies, in order to attract investors,
until at least one of the agencies delivers favorable ratings. This arrangement has been cited as
one of the primary causes of the subprime mortgage crisis (which began in 2007), when some
securities, particularly mortgage backed securities (MBSs) and collateralized debt obligations
(CDOs) rated highly by the credit ratings agencies, and thus heavily invested in by many
organizations and individuals, were rapidly and vastly devalued due to defaults, and fear of
defaults, on some of the individual components of those securities, such as home loans and credit
card accounts