Must-know: Why do lower-rated bonds have higher yields?

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Nov. 26 2019, Updated 10:26 p.m. ET

Bond rating changes and yield

By now, we’ve understood that yield tends to increase with an increase in duration. In this part of this series, we’d like to focus on how yield changes with changes in bond rating.

Inverse relationship

It’s worth noting the premium an investor may get while investing in high yield bonds over U.S. Treasuries. As we look at the graph above, we can make a clear distinction on the yield-to-maturity between the AAA rated “safest rating” and BB+, or lower sub–investment grade or junk bonds.

High yield bonds are further sub-categorized into various grades to distinguish between highly speculative, extremely speculative, and default companies. Highly speculative–grade companies normally have a higher probability of recovery in the case of default than the other lower-rated bonds.

We’ll learn more about investor preference and the availability of sub-grade high yield bonds in the market in the next part of this series.

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