High yield bonds and investment grade bonds are the two terms that confuse many people who are starting their journey as an investor. These words are not similar, but they tend to confuse the listener as they function inversely to each other. In this post, we will elaborate both of these terms along with their advantages and disadvantages.
High yield bonds
A high yield bond is a bond that offers a higher yield than most of the bonds in the market. The reason for such higher returns is that the issuing organization is not having a good credit rating in the market. This only way to lure investment for them is to offer a higher return of investment. These are rated below investment grade bonds.
Advantages
1. They offer a higher rate of return as compared to other bonds
2. If the rating of the issuing company improves, the value of bond may also appreciate
3. Bondholders are paid before the stockholder in case the company is winded up
Disadvantages
1. They have a higher default rate
2. The value of the bond can decrease with fall in the credit rating of the company
3. They are first targets whenever recessions hit an economy
Investment grade bonds
Investment grade bonds are those bonds that enjoy a higher credit rating in the market. These ratings are provided by rating agencies such as Standard & Poor’s and Moody’s. The companies that are ranked higher have a higher chance of repaying their debt. On the other hand, companies with lower credit rating have a lower chance of repaying their loans. Bonds are rated concerning alphabets A to C. Rating of ‘AAA’, and ‘AA’ denotes a high creditworthy company. A rating of ‘A’ and ‘BBB’ denotes an average creditworthy rating. Ratings of ‘BB’, ‘C’, ‘CC’ is denoted as low creditworthy bonds and are therefore also known as junk bonds.
Advantages
1. They are reliable and issues by trusted companies
2. Issuing authority has a stable financial status
3. They have a very less chance of default
Disadvantages
1. The rate of interest is less than other bonds
2. A larger some of investment needed to purchase high rated bonds
3. Even the best of companies can get down in economic crisis or if their subsidiaries make a loss.
