Bond markets usually adhere to this logic: If a corporate bond is deemed to have a higher risk of default than another, it should have a higher return. Yet, bonds can deviate from this supposedly elementary wisdom. The graph shows yields for four grades of corporate bonds: AAA, AA, A, and BBB. Most of the time, their yields are ranked this way from bottom to top—but not always. There are two reasons for deviations. 1. The maturity composition, or the average maturity of the bonds, within each category can differ substantially. Indeed, yield is more than just risk; it’s also a reward for allowing cash to remain illiquid. 2. Many bonds have the option to be called (i.e., redeemed) before maturity, and the likelihood of this happening may differ across risk grades. In an environment where interest rates are expected to move, both of these situations can matter. The graph shows frequent deviations from the risk ratings for the AAA and AA bond pools. Occasionally the yield for AAA bonds even gets close to the yield for A bonds.
How this graph was created: Search for “US corporate effective yield” and select the series you want. Click on “Add to Graph.” Then order the series by risk rating using the “move up / move down” buttons at the bottom of the “Edit Data Series” tabs so that the legends are ordered appropriately.
Suggested by Christian Zimmermann