A credit rating is an independent assessment of the creditworthiness of a bond (note or any security of indebtedness) by a credit rating agency. It measures the probability of the timely repayment of principal and interest of a bond. Generally, a higher credit rating would lead to a more favorable effect on the marketability of a bond. The credit rating symbols (long-term) are generally assigned with "triple A" as the highest and "triple B" (or Baa) as the lowest in investment grade (See below for definition of rating grades). Anything below triple B is commonly known as a "junk bond."

• Bonds rated AAA have the highest ratings assigned by rating agencies. They carry the smallest degree of investment risk. Issuer's capacity to pay interest and principal is extremely strong.

• Bonds rated AA are judged to be of high quality by all standards. They differ from the highest rated (AAA) bonds only in a small degree. Issuer's capacity to pay interest and principal is very strong.

• Bonds rated A have strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories.

• Bonds rated (BBB) are considered medium grade obligations. They are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or unreliable over any length of time. These bonds lack outstanding important characteristics and have speculative characteristics as well.
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Established rating agencies are for example Standard&Poors or Moodys.

It should be noted that the credit rating of a bond tells you nothing about the probability of losing money from changes, especially declines, in the bond's market value. A bond may not actually default but if many investors are concerned that it might then it's market value will decline sharply. This will bring substantial unrealised losses for those who still hold the bond. Many of these holders will now be sufficiently alarmed about the default risk inherent in continuing to hold the bond that they will sell, sometimes at almost any price, thus crystallising their losses. For more see the Corporate Bonds blog at www.davidandgoliathworld.com

Generally, bond risk refers to the possibility that the issuer will default (not repay). This is also called "credit risk" or "repayment risk". In a addition, bonds face "Interest Rate Risk", rising interest rates will make the value of a set of fixed future cashflows decline in current value. These are the 2 core risks faced.

In addition to credit risk, there are other risks associated with bonds, just as there are risks with owning any asset. Every asset has some risk whether that's your house, car, art collection, stocks or that baseball card collection in your attic. Bonds are no different. Some of the more common risks associated with bonds are credit risk (discussed above), interest rate/ market risk, call risk, liquidity risk and regulatory risk.

To determine credit risk, investors often look to a bond's rating, issued by independent ratings agencies such as Moody's, Fitch and Standard & Poors. The safest bond (in terms of repayment risk) is AAA-rated, and includes US Government debt and some highly rated corporate debt. A corporate or government bond issue rated AA or A+ is generally considered a safe investment. One rated BB or B- is riskier. Bond yields reflect this risk and generally lower rated bonds have higher yields than those of better credit quality.

Added by Stox723......There is another risk of Bond ownership. It is called "Opportunity Cost." This means that if you invest in a 10 year 5% Bond, you will receive 5% interest payments for 10 years. If you invest, lets say $10,000 in a Bond you will receive $500 per year in interest (usually paid semi-annually). Opportunity cost means that for this specific $10,000 there were other possible investments which you now cannot buy into with this money. The difference between the $500 earned and the income from the other possible investment is your opportunity cost.

Added by Beaufer99 (www.davidandgoliathworld.com). Aside from Default risk as described above, the important risks to an investor from holding bonds are as follows.

• Credit Spread Risk. The risk that the credit spread of a bond (extra yield to compensate investors for taking default risk), which is inherent in the fixed coupon, becomes insufficient compensation for default risk that has later deteriorated. As the coupon is fixed the only way the credit spread can readjust to new circumstances is by the market price of the bond falling and the yield rising to such a level that an appropriate credit spread is offered.
• Interest Rate Risk. The level of Yields generally in a bond market, as expressed by Government Bond Yields, may change and thus bring about changes in the market value of Fixed-Coupon bonds so that their Yield to Maturity adjusts to newly appropriate levels.
• Liquidity Risk. There may not be a continuous secondary market for a bond, thus leaving an investor with difficulty in selling at, or even near to, a fair price.
• Supply Risk. Heavy issuance of new bonds similar to the one held may depress their prices.
• Inflation Risk. Inflation reduces the real value of future fixed cash flows. An anticipation of inflation, or higher inflation, may depress prices immediately.
• Tax Change Risk. Unanticipated changes in taxation may adversely impact the value of a bond to investors and consequently its immediate market value.

What is a Debenture?

A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity.

These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years. Long maturity debentures are rarely issued, as investors are not comfortable with such maturities

Debentures enable investors to reap the dual benefits of adequate security and good returns. Unlike other fixed income instruments such as Fixed Deposits, Bank Deposits they can be transferred from one party to another by using transfer from. Debentures are normally issued in physical form. However, corporates/PSUs have started issuing debentures in Demat form. Generally, debentures are less liquid as compared to PSU bonds and their liquidity is inversely proportional to the residual maturity. Debentures can be secured or unsecured.

What are the different types of debentures?

Debentures are divided into different categories on the basis of: (1)convertibility of the instrument (2) Security

Debentures can be classified on the basis of convertibility into:

· Non Convertible Debentures (NCD): These instruments retain the debt character and can not be converted in to equity shares

· Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.

· Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.

· Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.

On basis of Security, debentures are classified into:

· Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of either the principal or interest amount, his assets can be sold to repay the liability to the investors

· Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.

The Bond price is the amount of the bond when it becomes mature. The coupon rate is the amount of interest payable on the bond.

Bonds have three major components

The first is the face value (also called par value). This is the value of the bond as given on the certificate or instrument. This is the value the bond holder will receive at maturity unless the issuer defaults. If bonds are retired before maturity, bond holders may receive a slight premium over face value. Investors pay par when they buy the bond at its original face value. The price investors pay may be more or less than the face value.

Bonds also have a coupon rate. This is the annual rate of interest payable on the bond. For the owner of a bond, the higher the coupon rate, the higher the interest payments the owner receives. The rate is set at the time the bond is issued and generally does not change. Most bonds make interest payments semiannually, although some bonds are offered with monthly and quarterly payments.

Until 1983, all bond owners received an actual paper bond certificate.

This inspired bond terminology. The loan amount appeared prominently on the face of the bond. Bonds included coupons that the owner detached, one

Price and interest rate on a bond are inversely related, if the bond price is low, rate will be high, if the bond price is high, interest rate will be lower.

1. Interest rate at any given time. A. as determined by market factors. B. Influenced by Federal reserve. 2. time to maturity. short,intermediate, or long term. 3. Coupon, rate of interest at the time of issuance.

Also of importance is whether or not the bond is Callable.

That is redeemable by the issuer prior to the original maturity date.

This usually occurs when current interest rates are below those that existed when the

bond was unwritten. In this case the company no longer has to pay the high interest rate (having bought back the original bonds from the current holders) and can issue new bonds (at the assumed lower current rate).

The disadvantage for the holder of the bonds being called(bought back) is that he/she is no longer earning a high interest rate and now has capital that if were to be

reinvested in bonds would be earning a lower interest rate than before.

Thus a callable bond can be considered as having a potential interest rate risk.