» Investing in Stocks and Bonds » Bond Default Risk

Bond Default Risk

The major purpose of bonds is to generate income and balance the volatility of stocks. Even though they are characterized by high levels of security, bonds do bring their dangers. The following table provides a grading of the risk associated with each bond type:

Bond Type Default level
US Treasury/agency Almost no chance for default
Munis Slight chance for default
Corporate bonds Higher risk for default
Junk bonds Higher risk for default
Foreign bonds High risk of default
Unrated bonds The highest risk for default

Factors Determining the Default Level

  • Potential returns

    The higher the risk level, the higher the potential returns. So, one factor of determining the default level of bonds is their potential returns.

  • Maturity period

    The relationship is the same - the longer the maturity, the higher the chance for default, since the longer the bondholder is exposed to the market volatility.

  • Ranking

    An additional factor that can be used when evaluating the chances for default of a bond is the ranking that is given to it by one of the two most reputable ranking services - Moody's Investors Service or Standard & Poor's.

    Both of the ranking services grade the trustworthiness of bonds on a scale starting from highest grade, passing thorough high grade, upper medium grade and ending at medium grade. Additionally, ranking is provided for low rated bonds. However, you should select bonds that fall in the ratings mentioned above. On the other hand, if you are a speculator, a low-rated bond may be of interest to you.

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