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determining bond returns relative to their quality. Those with high quality would generally have lower yields than those of lower quality, given the same time to maturity. However with junk bonds the investor is at a higher risk of losing his investment due to default. Many bond investors engage in diversifying their bond portfolio by investing in bonds from several categories. The portfolio's make-up can be adjusted to match the investor's risk/reward preference.

Investors must also pay close attention to upgrades and downgrades announced by the rating companies. many times an investment grade bond may be downgraded to junk status due to the issuer's risk of default. An example of it was the Lucent corporate bonds which were downgraded to junk status in 2001 as the company was going through turbulent times.

Bond Types

Bonds can be classified in several ways. The following is a good list of classes:

Government (Treasury) Bonds - Just as the name suggests, these are bonds issued by the federal government, specifically the Treasury Department. We already covered these types of bonds in the previous chapter, but as a refresher they include T-Bonds with maturities between 10 to 30 years, T-Notes with maturities between 1 to 10 years, and T-Bills with maturities between 3 to 12 months. Of these, T-Bills do not pay periodic interest; instead, they are purchased at a discount to their face values and at maturity they can be redeemed for their full face values. The others, however, have semi-annual interest (coupon) payments with their principals (face values) redeemable at maturity. …