Investment Grade Bonds

Investment grade bonds are issued by corporations or municipalities with good credit ratings. When a bond is classified as investment grade, the credit rating agencies consider it likely that the bond issuer will meet its obligations to pay interest and pay back principal on the bonds.

Recalling that a bond is essentially a loan of cash to a corporation or government, it is not surprising that bond issuers have credit ratings. These ratings are given by three agencies: Standard & Poors, Moody's, and Fitch. IF the bond rating is BBB- or higher for Standard and Poors or Fitch, these are investment grade bonds. For Moody's, bonds are considered investment grade if the rating is Baa3 or higher.

Short term bonds have a different rating system. For S & P and Fitch, A3-A1+ are considered investment grade, while this is true for P-3 to P-1 for Moody's.

These are further divided into low medium, upper medium, high grade, and premium bonds, depending on the credit rating. The better the credit rating, the lower the interest rate that has to be paid, since its a less risky loan. If the credit rating is low, the bond issure must pay a higher rate of interest due to the riskier nature of the loan.

While investment grade bonds are considered relatively safe investment risks, they are still somewhat risky as compared to US government bonds. As such they pay higher interest rates, even for those with the best ratings. The difference between interest rates paid on investment grade and US Treasury bonds is called the investment grade spread. If the spread is small, that is a sign the economy is healthy. The larger the spread, the more unstable the economy may be.

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