Bond Ratings
Bond rating entails grading the credit qualities of a certain bond. This is done by independent service providers who analyze the financial ability of a bond issuer to repay the principal, bond, and interest within a given timeframe. The bond ratings, in this case, include AAA, BBB, CCC, and D. Bonds rated AAA have the highest rating implying an exceptionally strong ability to meet financial obligations. According to Kenny (2018), Fitch and Moody’s gave the U.S. government the AAA rating. Similarly, Exxon Mobil, Microsoft, Johnson & Johnson, and Automated Data Processing have AAA ratings. The strength of AAA bonds is that they are the safest (Kenny, 2018). As such, they are categorized amongst the investment grade bonds making them receive significant regulatory implications. For instance, a bank trust department excessively favor investment grade bonds, among them the Triple-A bonds, as required by the fiduciary duty owed to customers (Kennon, 2018).
Nevertheless, it is extremely hard to attain an AAA rating. Also, AAA bonds are deliberated to be below sovereign bonds given out by well-run governments. AAA bonds are only superior because they possess the ability to tax and hold standing armies, which assure the settlement of obligations. Similarly, AAA bonds have the lowest yields since one is only able to achieve the peace of mind. Hence, one loses in income since other investors accept to bid up the bond price, particularly when things go south, which is termed "flight to safety" (Kennon, 2018). On the other hand, BBB bonds possess an ample capacity to meet financial obligations, but are more exposed to hostile economic conditions or varying circumstances. BBB bonds are still regarded investment grade (Kenny, 2018). The strengths of BBB bonds include having higher yields, which is claimed by investors in order to reimburse for the increased risk. Upon the weakening of the economy, investors abruptly demand even higher earnings for the risky BBB bonds compared to the less risky AAA counterparts.
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Despite BBB bonds being investment grade, they exhibit a substantial rise in the risk of default. Also, the bond market is regarded to be "smarter" than the stock market, hence, BBB bonds start diminishing severely compared to AAA bonds in terms of the price some months before the stock market peaks. Similarly, there are the CCC bonds, which are at the mercy of favorable business, financial and economic situations to meet financial pledges (Kenny, 2018). They boost the general returns in one’s portfolio while evading the higher volatility of stocks by offering higher yields compared to investment-grade bonds. Also, they have the chance to do better if upgraded upon the improvement of business. Conversely, these bonds are of low quality, hence, regarded non-investment grade. The CCC rating signifies an exceedingly high-risk bond making banks not to be permitted to invest in them.
Lastly, there is the D bond, which is the poorest rating, given to bonds already in default (Kenny, 2018). These bonds are advantageous because they are issued with ten-year terms, or fewer, and can be called after 4 to 5 years. Similarly, they perform better during the expansion period of the business cycle since the underlying corporations are less probable to default during good times. Therefore, a good economy lowers its risk. Nevertheless, in the event that the business fails to pay, one loses one-hundred percent of their initial investment.
References
Kennon, J. (2018). AAA Ratings Are Rare and Represent the Highest Quality Bonds. Retrieved from https://www.thebalance.com/aaa-rating-triple-a-357798
Kenny, T. (2018). The Scoop on Bond Credit Ratings. Retrieved from https://www.thebalance.com/what-are-bond-credit-ratings-417074
