Credit rating changes:

When a bond is issued, rating agencies assign a rating to give investors an indication of the bond’s investment quality and relative risk of default. The first four rating categories are considered investment-grade bonds, while the lower categories are considered speculative. A bond’s rating affects the borrowing cost for the issuer. Typically, higher-rated bonds pay a lower interest rate than lower-rated bonds. After the bond is issued, the rating agencies continue to monitor it, making changes if warranted. A bond’s price will decline when a rating is downgraded and will increase when a rating is upgraded. The price change brings the bond’s yield in line with other bonds with a similar rating. However, these price changes are typically minor if the rating changes by only one notch. Certain downgrades are more significant than others. You should review whether you want to continue to hold the bond if any of the following occur:

• A downgrade moves a bond from an investment-grade to a speculative rating.

• A downgrade of more than one notch occurs.

• A series of downgrades occurs over a short period of time.

Interest rate changes:

Interest rate changes will typically cause a bond’s price to fluctuate more than credit rating changes. When interest rates rise, a bond’s price will decline, while the bond’s price will increase when rates decrease. For instance, assume you own a 10-year bond that pays a 3% coupon, while bonds of the same maturity currently pay 4%. It would be difficult to find someone willing to pay the full principal amount to receive 3% interest, when they could easily purchase another bond with 4% interest. To encourage someone to purchase the bond, you would have to lower the price enough so the bond pays the equivalent of 4%.

To extend the example further, suppose you own two bonds paying 3% — one with a five-year maturity and another with a 10-year maturity. Would you be able to get the same price for both bonds? Since the bond with the 10-year maturity is paying a lower interest rate for a longer period, you would have to discount that bond more. One of the reasons longer-term bonds typically pay higher interest rates is because there is more risk that interest rates will change during the bond’s life.

In summary, before selecting a maturity date for a bond consider when you will need your principal. If you sell before the bond matures, interest rate and credit rating changes will affect the selling price.