Credit Risk associated with bonds

Credit Risk associated with bonds

Credit Risk associated with bonds

Credit Risk associated with bonds are distinguished by their credit ratings. A rating provides an indication of the risk that the issuer will fail to pay interest and principal for a particular bond when those payments are due. This risk credit risk associated with bonds.

Rating agencies

A bond issuer pays a rating service to examine its financial condition, culminating with a rating for that bond issue. Two of the most prominent rating services are Standard & Poor’s and Moody’s. Standard & Poor’s gives ratings from AAA (the highest) to D (the lowest). Ratings considered investment grade are AAA, AA, A and BBB. Moody’s gives ratings from Aaa (highest) to C (lowest), and their investment grades are Aaa, Aa, A, and Baa (Baa bonds may have speculative elements, a fact that must be disclosed in prospectuses of funds that concentrate in investment-grade bonds). Any lower rating is considered non-investment-grade. US government issues are considered AAA or Aaa because they are the highest grade bonds available.

Coupon rate

The lower the coupon rate, the more volatile the price of the fixed income security will be for a given change in interest rate. This, too, is due to the time value of money, since the lower interest payments make the maturity value a larger proportion of total cash flows. The proof of this statement is in zero coupon bonds, which are the most volatile of all for a given maturity. When both factors come together in a single security, such as in a long-term, zero coupon bond, the bond demonstrates high price volatility.


The concept of duration indicates the price sensitivity of a bond or bond portfolio to changes in interest rates. Be aware that the concepts of duration and maturity of a bond are not the same thing. Duration measures interest rate risk; maturity is the number of years until the bond will pay its par value. The higher the duration, the greater the potential price volatility with changes in interest rates. In general, a bond’s duration times the change in interest rates approximately equals the price change in the bond due to interest rate changes.

The duration of a coupon bond will always be less than its years to maturity. An a retirement planner, knowledge of a bond or bond funds duration can help you assess the interest rate risk associated with the client’s overall portfolio. This is important because risk-averse clients may not want to own a bond or bond fund that fluctuates widely.

Credit risk associated with bonds

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Credit Risk associated with bonds

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