The key question for bond investors is: “Will I get my money back?” As long as the issuer is making interest payments, the principal is secure; it’s when the issuer misses a payment that the possibility of default arises, putting investor principal in jeopardy. The main purpose of bond research is therefore to find out how secure interest payments are – i.e. evaluate the issuer’s ability to continue to make them.
Credit Rating Limitations
There are several credit rating agencies that rate bonds based on the issuer’s ability to make payments. The methodologies and ratings designations vary somewhat from agency to agency (generally going from AAA for the most secure debt all the way down to C- for junk and D for default), but as the recent defaults in investment grade bonds like Lehman Brothers showed, credit ratings alone may not mean much these days as they can be assigned or maintained for purposes other than assessing credit risks.
Common sense is still the best bond research tool.
Maturity: Long vs. Short Term
The longer the bond, the greater the risk. An AAA rating on a 20-year bond may mean little, unless it’s a U.S. Government or an insured bond, because a lot can happen to an issuer over 20 years and if the issuer’s financial condition deteriorates, its credit rating will be cut, so what started as an AAA can theoretically end up as a C-. The longer the bond, the greater the risk, period. By the same token, a junk bond rating on a long bond may be lifted if the issuer’s financial condition improves. On the other hand, an issuer is not likely to go from AAA to C- in a couple of years, so credit ratings for shorter-term bonds are more secure.
Issuers’ Stock Data
Most corporate bonds are issued by publicly traded companies. There are some companies that have gone private but their bonds are still trading. The problem with these bonds is lack of readily available financial information as private companies do not have to file quarterly earnings reports with the SEC, so it makes sense to stick with bonds of publicly traded companies. On the other hand, a group of investors is very unlikely to buy out a company that is in poor financial condition, so its bonds may be secure.
Stock investors are behind bondholders when it comes to a company’s financial obligations. Before a company can show earnings or pay dividends, it must pay bond interest. So if a company is reporting profits, it shows that it has the funds to pay bond interest; if a company is reporting losses, the question is whether they still have enough money to pay bond interest. Were those paper losses (depreciation, goodwill impairment) or cash flow problems?
Broker Bond Listings and Desks – Best Source of Information
Broker bond listings include all the pertinent information: current yield, price, maturity, call dates, and credit ratings and CUSIP numbers. CUSIP is a unique identifier under which all pertinent bond information is listed but CUSIP services are cumbersome and expensive and are geared towards institutions – you can obtain all the information you need from your broker’s bond desk by giving them the CUSIP number of the bond you are interested in.
