Page 53

In this case the bond yield moves down by 17 basis points:

6%—5.83% = 0.17% or 17 basis points

As can be seen, the bond price and the bond yield always move in opposite directions. This concept is often a mystery for many but, hopefully the above example has shed some light on the mechanics of bond yields relative to their prices.

Bond Ratings

Bonds, like any other type of investment, come with different levels of risks. A bond investor must always be aware of the associated risks. While it may be true that bonds offer a certain degree of safety over other types of securities, there is always a chance that the issuer may default. Defaulting on bonds means that the issuer may not be able to fulfill the obligation to repay the investors, and in those cases, the investors may lose part or all of their investment without recourse.

So how can the bond investor determine the quality of the bonds she may be interest in? The good news is that the investor can refer to the bond ratings to get that information. There are several organizations that rate bonds. Of those, two are the most reputable and most consulted when it comes to determining the quality of various bonds. They are Standard & Poor’s (a division of McGraw-Hill) and Moody’s. These companies do all the research and assign grades to various bonds, which are then used by investors to gauge the quality of the bonds. Their research covers a wide range of criteria, including the issuers’ credit history, historical performance, current and future financial standing, and more.

The grade categories assigned by Standard & Poor’s (S&P) are: …