If all bonds were created equal, choosing among them would entail little more than comparing yields. But in truth they are far from equal, which is why they are rated on their credit quality by major rating services like Moody’s and Standard & Poor’s.
Bond ratings are based on the likelihood that the bond’s issuer will default, failing to repay its obligation to investors. The highest-quality bonds receive a rating of AAA from Standard & Poor’s (Aaa from Moody’s). At the other end of the spectrum, bonds rated DDD or lower by S&P are already in default. As you might guess, lower-quality bonds generally offer higher returns as an incentive for investors to purchase them in spite of their higher level of risk.
Bonds rated BBB or higher by Standard & Poor’s (Baa or higher by Moody’s) are considered “investment grade”—that is, appropriate for consideration of purchase by prudent investors. Bonds with ratings below this threshold are considered noninvestmentgrade or “junk.” Junk bonds offer higher yields but are considered to be highly speculative investments due to the company’s risk of default.