What is the rating of a bond?

    Published: 06-16-2009
    Views: 10,371
    Financial Advisor David John Marotta explains bond ratings

    David John Marotta

    David John Marotta is the President of Marotta Wealth Management, a fee-only financial planning and asset management firm in Charlottesville, Virginia. He is an oft-quoted writer and speaker on financial matters and his weekly financial column can be found at www.eMarotta.com

    Host: What is the rating of a bond?

    David Marotta: The rating of a bond is the measure of the quality or safety of a bond and there are three or four rating companies that provide ratings. So, the very, very top quality bonds from a company that's very very financially stable are rated AAA and the worst bonds are rated D. So, there is a whole scale in between. The higher quality the bond or the higher rating that the company has for their financials, then the lower interest rate it needs to pay and the higher it will cost to buy it. Bonds that are rated at least BBB or better are called Investment Grade bonds and Investment Grade bonds are considered relatively safe. There is not very much chance that the company is going to go out of business and default on their bonds. Once you get lower than BBB, you get what's called junk bonds and Junk Bonds are also called High Yield bonds and they used to be called Junk Bonds, now they are called High Yield bonds because people are more willing to buy a high yield bond than buy a junk bond but you have to remember that those two are the same term. So, a junk bond is not investment grade and there is a chance that the company is going to go bankrupt and junk bonds end up acting a little bit more like stocks. So, they might pay a higher rate of return when the economy is doing well and the markets are doing well but the minute the economy turns sour or we have a recession and the stock market drops, junk bonds start defaulting on their loans and so, the junk bond returns suddenly starts going way down because instead of these nice high rates of returns, you are loosing some of the principal money as the companies go bankrupt.