Types of Corporate Bonds
- Investment Grade. Bonds considered to carry minimal likelihood of default are labeled “investment grade” and are rated Baa3 or higher by Moody’s, or BBB- or higher by Standard & Poor’s and Fitch Ratings.
- High Yield. Bonds with a rating of BB (Standard & Poor’s, Fitch Ratings) or Ba (Moody’s) or below are considered “speculative grade” as they a greater risk of default than bonds rated investment grade. Such bonds, most often referred to as “high-yield bonds”, are generally issued by newer or start-up companies, companies that have had financial problems, companies in a particularly competitive or volatile market or companies with aggressive financial and business policies.
- High yield issuers must pay a higher interest rate to attract investors and compensate them for the risks associated with investing lower credit quality bonds. Organizations that issue highyield debt may include U.S. corporations, U.S. banks, foreign governments and foreign corporations.
For more information on credit ratings, see the section labeled “Credit Analysis and Other Important Considerations: Credit Ratings”, later in this guide.
Some differences between investment grade and high yield corporates are:
- Maturities. High-yield bond maturities are typically 10 years or less. Few high-yield issues have the longer maturities generally associated with investment-grade corporate and municipal bonds. In fact, many high-yield issues are called “notes” rather than bonds because of their shorter maturities.
- Call protection. Such protection often extends for the first five years for high yield bonds.
Bond Types. Both corporate investment grade and high yield bonds come in different varieties:
- Straight cash bonds are the corporate market’s “plain vanilla” bond, offering a fixed coupon rate of interest that is paid in cash, usually in semiannual payments, through the maturity or call date.
- Split-coupon bonds offer one interest, or coupon, rate in the early years of the bond’s life, followed by a second interest rate in later years. Split-coupon issues in which the interest rate increases in later years are also called step-up notes.
- Pay-in-kind (PIK) bonds allow the issuer the option of paying the bondholder interest either in cash or in additional securities.
- Floating-rate and increasing-rate notes (IRNs) pay fluctuating or adjusted rates of interest based on an interest rate benchmark or a schedule of payments.
- Extendable reset notes give the issuer the option of resetting the coupon rate and extending the bond’s maturity at periodic intervals or at the time of specified events. In exchange for these options, the bondholder recieves the right to sell, or “put,” the bond back to the issuer.
- Deferred-interest bonds pay no interest to the bondholder until a future date.
- Convertible bonds may be converted into another security under stated terms. Most often that security is the corporate issuer’s common stock.
- Multi-tranche bonds offer bondholders several tiers of investments within the same issue. Typically, the tiers may vary in their targeted maturities and credit quality.