Bonds pay interest that can be fixed, floating or payable at maturity. Most debt securities carry an interest rate that stays fixed until maturity and is a percentage of the face value, or the principal amount. For example, a $1,000 bond that pays a 6% coupon, will pay an investor $60 annually, typically $30 twice yearly.

A bond’s maturity refers to the specific future date on which the investor’s principal will be repaid. Maturity ranges are often categorized as follows:

• Short-term notes: maturities of up to five years;
• Intermediate notes/bonds: maturities of five to 12 years;
• Long-term bonds: maturities of 12 or more years.

Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance. Some individuals might choose short-term bonds for their comparative stability and safety, although their investment returns will typically be lower than would be the case with long-term securities. Alternatively, investors seeking greater overall returns might be more interested in long-term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk.

Bond choices range from the highest credit quality U.S. Treasury securities, which are backed by the full faith and credit of the U.S. government, to bonds that are below investment—grade and considered speculative. Since a bond may not be redeemed, or reach maturity, for many years, credit quality is another important consideration when you’re evaluating a fixed-income investment. When a bond is issued, the issuer is responsible for providing details as to its financial soundness and creditworthiness. But how can you know whether the company or government entity whose bond you’re buying will be able to make its regularly scheduled interest payments possibly decades after you make your purchase? Rating agencies assign ratings to many bonds when they are issued and monitor developments during the bond’s lifetime.

Major rating agencies include Moody’s Investors Service, Standard & Poor’s Corporation and Fitch Ratings. Each of the agencies assigns its ratings based on in-depth analysis of the issuer’s financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond. The highest ratings are AAA (S&P and Fitch Ratings) and Aaa (Moody’s). Bonds rated in the BBB category or higher are considered investment-grade; securities with ratings in the BB category and below are considered “high yield,” or below investment-grade. While experience has shown that a diversified portfolio of high-yield bonds will, over the long run, have only a modest risk of default, it is extremely important to understand that, for any single bond, the high interest rate that generally accompanies a lower rating is a signal or warning of higher risk.

How can you find out if the credit factors affecting your bond investment have changed? Usually, rating agencies will signal they are considering a rating change by placing the security on CreditWatch (S&P), Under Review (Moody’s) or on Rating Watch (Fitch Ratings). The rating agencies make their ratings available to the public through their ratings information desks.

Yield is the return you actually earn on the bond, which is based on the price you paid and the interest payments you receive. There are basically two types of bond yields you should be aware of: current yield and yield-to-maturity or yield-to-call. Current yield is the annual return on the dollar amount paid for the bond and is derived by dividing the bond’s interest payment by its purchase price. If you bought at $1,000 and the interest rate is 6% ($60), the current yield is 6% ($60 /$1,000). If you bought at $850 and the interest rate is 6% ($60), the current yield is 7.0% ($60/$850).

Yield-to-maturity and yield-to-call, which are considered more meaningful, tell you the total return you will receive by holding the bond until it matures or is called. It also enables you to compare bonds with different maturities and coupons. Yield-to-maturity equals all the interest payments you will receive from the time you purchase the bond until maturity, plus any gain (if you purchased the bond below its par, or face, value) or loss (if you purchased it above its par value). Yield-to-call is calculated the same way as yield to maturity, but assumes that a bond will be called and that the investor will receive face value back at the call date.