Must-know: How the U.S. debt market offers multiple investment avenues
The U.S. debt market
The U.S debt market offers enough investment avenues to its investors. Depending on an individual’s investment goal, return expectations, and risk appetite, the most appropriate avenue of investment can be selected. The U.S. debt market is broadly divided into the following areas:
- High-yield bonds market
- Leveraged loans market
- Treasury securities
- Investment-grade corporate bond market
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High-yield bonds or junk bonds are bonds issued by companies with an investment-grade credit rating of BB+ or lower. High-yield bonds pay a higher yield than Treasury and investment-grade corporate bonds as an additional credit risk premium. These are generally issued for leveraged buyouts and other takeovers by companies with questionable credit.
These are syndicated loans extended to companies or individuals that already have considerable amounts of debt. On the surface, leveraged loans look similar to high-yield bonds, but these asset classes are very different. Leveraged loans have limited interest rate risk because they have a floating rate feature. Since leveraged loans are pegged to a benchmark, usually the return on Treasury securities, these are protected from the rising yields on Treasury securities.
A U.S. Treasury security is a debt financing instrument issued by the U.S. government. They are simply referred to as Treasuries. Such instruments include bills, notes, bonds, and inflation-indexed bonds issued by the government.
Investment-grade corporate bonds
These bonds are issued by long-established companies with strong balance sheets. The companies are rated as “investment grade” because they have a lower chance of defaulting on their debt. Bonds that are rated BBB- and above by Standard & Poor’s, and Baa3 and above by Mood’s, fall in this category. Investment-grade bonds are of medium-to-highest credit quality with AAA or Aaa—being the highest rating that indicates highest safety. Very few corporations including Johnson & Johnson (JNJ) and Microsoft (MSFT) are rated AAA or Aaa by rating agencies.
Exchange-traded funds (or ETFs) such as the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) invest strictly in investment grade corporate bonds while ETFs such as the Vanguard Total Bond Market ETF (BND) and the iShares Core Total U.S. Bond Market ETF (AGG) invest in the entire investment-grade bond market including Treasuries.
The intent of this series is to update our readers on how these four major components of the U.S debt market have performed over the past week, which ended May 23. To learn about how the high-yield bond market performed last week, continue reading the next part of this series.