Types of High-Yield Bonds
Bond investing is often divided into two categories: investment grade and high yield. Although high-yield bonds are officially non-investment grade, they can provide attractive investment opportunities. Analyzing high-yield bonds requires a level of expertise, and investors entering the category may want to invest through mutual, closed-end or exchange-traded funds.
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Definition
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Whether a bond is high-yield or investment grade is determined by the credit rating of the bond issuer. The rating agencies of Moody's, Standard & Poor's and Fitch Ratings give debt issuers letter scores based on their financial strength and ability to meet interest and principal payment obligations. Non-investment grade, high-yield bonds have credit ratings below BBB from S&P and Fitch Ratings or below Baa from Moody's.
Corporate High-Yield Bonds
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A significant portion of the debt securities issued by U.S. corporations are high-yield bonds. High-yield bond issuers include companies like Goodyear Tire & Rubber, Continental Airlines and Rite Aid. High-yield bond issuers must pay a significant yield premium over what investment-grade bonds pay. In March 2011, the high-yield bond index quoted on the Investing in Bonds website had a yield of 7.81 percent. The investment-grade bond index was yielding 4.53 percent.
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High-Yield Municipal Bonds
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Municipal bonds are issued by state and local governments. The investment advantage of municipal bonds is that the interest they pay is exempt from income taxes. Municipal bond issuers are also given credit ratings, and some municipal bonds are non-investment grade. A report by Van Eck Global, an investment firm, noted high-yield municipal bonds have a significantly lower default rate than corporate-issued high-yield bonds. Historically, high-yield municipal bonds paid interest about 2.4 percent higher than investment-grade municipal bonds.
Foreign Government Bonds
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Foreign governments which issue bonds are also rated and may pick up a non-investment grade rating. For example, in March 2011, the government debt of Greece was further downgraded deep into high-yield territory when Moody's lowered the country's credit rating from Ba1 to B1. Countries with low credit ratings also must pay higher yields on their bonds. The best outcome for an investor is to buy high-yield bonds from a country whose credit rating is then upgraded. This will result in a boost to their market price.
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