High-grade corporate bonds look decent
— -- When you were a wee tyke and you tried to grab some of Grandma's freshly baked high-yield securities, she probably whacked you with a rolled-up prospectus and said, "Don't reach for yield!"
Well, Granny was right: People who dug into high-yield, high-risk junk bonds got burned pretty badly the past 12 months. And high-yield bonds are still too hot to handle. But you can find some tasty high-grade corporate and municipal bonds these days.
When you buy a bond, you're buying a long-term IOU. If you buy the current 10-year Treasury note, for example, the government promises to pay you 2.75% a year for a decade. A $10,000, 10-year T-note, then, would pay you $275 a year. When it matures, the Treasury will repay your $10,000 principal.
In the case of the Treasury, credit risk isn't a concern: If the government doesn't have the money, it can always print some more. Printing money is inflationary, and we'll get to that in a bit, but you can bet that if the government borrows $10,000 from you, you'll get $10,000 back.
Things get a big murkier if you lend money to a corporation by buying a corporate bond. Companies can't print money, and sometimes they go out of business altogether, transforming their bonds into very nicely engraved fish wrap. Corporate bonds usually yield more than Treasury securities, because investors want to be paid extra interest for taking on the risk of default.
Because of the recession, defaults have been unusually high, and they are headed higher, says Moody's Investors Services. The current global default rate is 7% of all issuers, up from 4.1% at the end of 2008 and 1.5% just 12 months ago.
Things are likely to get worse before they get better. Defaults rise well after the economy bottoms. Moody's sees global default rates peaking at 14.6% in November.
Because default risk has soared, so have yields on corporate bonds. As with people, companies with the worst credit ratings pay the highest interest rates on their loans. Wall Streeters call bonds with very high yields "junk bonds"; they have really rotten credit ratings.
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