Fixed income investors do have a few investment alternatives. The Treasury market is the most obvious choice, where securities ranging from 3 month to 30-year maturities trade at a virtually risk-free interest rate. These are for investors who don't like risk and prefer the liquidity offered by short-term maturities. There are also agency securities, a sister market to Treasuries, where securities trade at slightly higher interest rates than in the Treasury market. While agency securities typically have some degree of risk associated with them, the risk is usually negligible. Corporate bonds offer an additional opportunity for fixed income investors.

Corporations issue bonds to help fund operations. Their maturities are determined by company need, but rates are determined by the market and the state of the economy. Not all corporations, only those with very high quality names, have the option to offer short term securities. Rating agencies assess the company's risk and the well being of the industry and the economy overall. The two most widely reported credit-rating agencies are Moody's and Standard & Poor's. For the purposes of our discussion we will be using Moody's credit ratings. Essentially, what these agencies do and what the ratings mean are used to determine the risk on the security. These agencies assign a letter value to the security that helps an investor determine its quality. Higher quality securities offer a lower interest rate than lower quality securities. This is the fundamental rule of investing, as greater risk equals greater reward (or greater punishment).

Credit Rating Discussion

Aaa Bonds
Aaa is the designated definition for the highest quality of corporate bond. Securities carrying this rating are judged to have the smallest degree of investment risk. The principal is secure and interest payments are protected by a robust margin. While there is always a chance that various protective elements can change, these changes are easy to visualize. The Aaa rating basically means that it is highly unlikely for any drastic changes to occur that would erode the fundamentally strong positions on these securities.

Aa Bonds
Aa is the rating given to securities that are judged to be of high quality by all standards that Moody's or Standard & Poor's use. Together with Aaa bonds, they make up what are generally known as high-grade bonds. Aa bonds are rated lower than the best bonds because sometimes margins of protection are not as large as Aaa securities. Also, fluctuations in protective elements may be more likely to occur. Having these elements present generally make the long-term risk appear somewhat larger than the Aaa securities.

A Bonds
Securities that are rated A possess many favorable investment attributes. They are considered upper-medium grade obligations. Factors related to principal and interest payments are considered adequate. In A bonds, however, there may be more elements present that suggest a susceptibility to risk in the foreseeable future.

Baa Bonds
Baa bonds are considered medium-grade obligations. They are neither highly protected nor poorly secured. Interest payments and security on the principal appear adequate for the present, but there may be certain protective elements lacking. These securities have the possibility of being unreliable over any great length of time. These bonds lack outstanding investment characteristics, making them attractive to speculators at the same time.

Ba and below ...
There are a number of securities that reporting agencies also rate, but these are considered low-grade status. The ratings can range from Ba all the way to C. There is very little protection offered in these securities and they typically have a high probability of default. Securities that have credit ratings lower than B are considered junk bonds, or as some investors call them, high-yield bonds. Investors are rewarded for being speculative in these high yielding securities.

Corporate Bond Comparison

From Aaa to Baa
Investors who keep their investments within the highest-grade to medium-grade range will make a higher rate of return than on Treasuries. As the chart below shows, yields grow higher over the same time period as one increases risk.

The chart above also compares corporate bonds with the 10-year note. One often hears the term "benchmark" applied to the 10-year note. Corporate bonds are matched against the Treasury security that holds benchmark status in order derive a relevant interest rate. Not only does it make it easier to assess risk by pricing corporate bonds this way, it gives investors some idea as to what they are getting themselves into. As the probability of default and credit ratings increase, yields grow higher and begin to separate themselves from the benchmark 10-year note.

The chart below shows the long term spread performance since 1990.

As one can see, corporate bonds follow the same patterns over time as the 10-year note. All of the recent economic instability can be seen from the chart over the past ten years. Periods of economic growth generally see lower yields, with increased interest in corporate bonds.

Why Investors Care
Corporate bonds offer an attractive alternative to the Treasury market. In periods of economic growth, such as the one we are about to enter, corporate bonds offer higher yields while remaining strong relative to risk factors. Since the probability of default decreases in periods of economic growth, corporate bonds become a more attractive investment than Treasury securities over the short term. Now is particularly a good time to look into corporate bonds. Past weeks have seen bond issuance rise as corporations look to fund future endeavors in this growing economy. In fact, the week of March 11-15 saw a near record amount of corporate supply hit the bond market.

While Treasuries remain the realm for the risk-averse, it is worthwhile to note that corporate bonds are available to the average investor. With yields generally higher than Treasuries and agency securities, corporate bonds are similar to the stock market in that the level of risk becomes something that investors care less about in strong economic times. With market players expecting a "V"-shaped economic recovery this year, corporate bonds will remain an especially attractive investment.