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Investment-grade bonds are bonds with an independent rating high enough to indicate that they are reasonably safe investments. Some sort of return is guaranteed, and the rating indicates a low likelihood of complete company collapse or other problems that might interfere with the repayment of bonds. Investment publications closely track bond ratings for the benefit of investors and tend to publicize downgradings, especially when they result in a drop from investment to “junk” status. These publications can have specific recommendations on investment-grade bonds to consider buying.
Grading systems vary from company to company, and generally consist of a combination of letters. Something like an AAA bond is an investment-grade bond, in this case of the highest quality. A BAA bond is of lower quality, but still qualifies for investment, while a B or CCC bond is considered “junk,” meaning it carries substantial financial risk and should be avoided, if at all possible.
Investors usually want the best investment-grade bonds. They may be willing to accept bonds of lower grades for speculation, or as part of a package where bonds of different grades are mixed together and sold as a unit, rather than individually. Investors are wary of bonds with low ratings, as they generally do not want to expose themselves to high and avoidable risks. Some speculators may take on bonds at the higher end of the junk rating schedule.
When investment analysis companies decide to lower a rating, turning investment-grade bonds into junk bonds, it can be controversial. A line has to fall somewhere, and dropping down a single class can turn a bond from a worthwhile investment to a dubious one overnight if the bond was hovering on the line between good and bad. Companies may protest such downgrades, claiming they decrease consumer confidence and make it hard for them to recover. Since downgrades are usually the result of unfavorable information about a company's future, the company may argue that the decision effectively condemns them, as investors will flee the company to avoid losses.
Certain types of bonds are not rated. Generally, those issued by the national government are not subjected to rating because they are guaranteed. Municipal bonds may be rated, depending on the nation and the policy of ratings agencies. Just like companies, municipalities can experience a cash flow crisis if their formerly investment-grade bonds experience a sudden downgrade and are classified as junk by ratings agencies, making it hard to access credit for various municipal endeavors.