What are Investment Grade Corporate Bonds?

Investment grade corporate bonds are low-risk bonds. Because they are bonds, they are not tied to equity. Instead, they are like debt notes issued by a corporation. Investment grade essentially means they are the lowest possible risk level aside from treasury bonds. Treasury bonds are always the lowest risk option. The federal government guarantees those bonds, and oftentimes even adjusts for inflation. However, treasury bonds typically have lower yields than corporate bonds, so investment grade corporate bonds may be a more attractive option.

Investment Grade Rating System

Investment grade is a general term used to describe how the bond is classified by various indexes and ratings companies. No one company issues the "investment grade" stamp of approval. Instead, it is a term often used by investment houses or corporations to inform a potential investor of the low risk level of the bond. 

A, B, C Rating System

Investment grade actually points to the other ratings a bond has received by either Standard & Poor's or Moody's. These organizations rate bonds based on their relative risk with an A, B, C system. There are many levels within the A, B, C system. The scale may seem confusing, but the closer a bond is to A, the better. For example, BBB is higher than BB. This is actually the threshold of investment grade. Any bond that has a rating of BBB- or higher is investment grade. Any lower rating, even BB+, is considered a junk bond. A junk bond is one who's value is significantly compromised for a number of reasons and should not be purchased in most cases.  

Investment Grade vs. A, B, C

As mentioned previously, an investment grade corporate bond will never be as low-risk as a government bond. Even the lowest risk bond issued by a corporation carries some inherent risk if the company goes bankrupt and cannot repay the debt. The grading system shows a likelihood this will happen. For example, when Standard & Poor's gives a bond an A rating, it is saying the corporation has a low likelihood of bankruptcy based on its current financial profile. This can change, though, with a market swing or corporate problem. The bond will rarely drop to a junk bond status. Deciding to purchase a BBB bond is particularly risky, however, because it could easily slip down to BB+ or BB, meaning it has lost its investment grade rating. As such, many investors use only A, AA or AAA rated bonds and ignore the investment grade threshold.

Purchasing Bonds for Diversity

Investment grade bonds are still considered lower risk than equities, commodities or currencies. As such, carrying some bonds in a portfolio is a way of reducing the total risk spread and diversifying the portfolio. A well-diversified portfolio will have a mix of government and corporate bonds to vary potential gains and potential risk levels. Ultimately, an investor with a higher appetite for risk can move into more investment grade corporate bonds than government bonds to increase the chance for high interest payments and profits. 

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