Booyah Breakdown: Bonding With Bonds, 2

Corporate bonds are graded by special rating agencies such as Standard & Poor's or Moody's Investors Service. A triple-A rating is the highest grade a company can get. That means, as a bond investor, you can sleep well knowing the company has the money and the integrity to pay you back, with interest, when your bond matures.

As a company's flawlessness disappears, so does its rating. The second-highest rating is a double-A, then single-A, followed by a triple-B, a double-B and so on.

But even a solid company with a high rating offers a better yield, or interest rate, than Treasuries. That's because you take on a bit more risk by lending your money to a company than you do with Uncle Sam. So you need to be compensated for that extra risk, hence the higher interest rate, or yield.

You can take an even riskier path and invest in high-yield bonds. Those bonds are issued by companies that have ratings below triple-B. That means the company's financial situation is a mess and the probability that it's going to default on your bond is high.

But, of course, there's always the chance the company will come through for you. So to entice you into taking that gamble, these companies offer a really high yield.

Of course there are other types of bonds -- foreign bonds, mortgage bonds, etc. -- but that's fodder for another day.

Establishing a Bond's Price

Now remember, a bond's face value is usually either $1,000 or $5,000, but you don't necessarily have to pay that upfront. Bond prices fluctuate. And the market's perception of the bond and its issuer is one of the biggest reasons for that volatility.

Let's take, for example, a bond with a $1,000 face value. If other investors don't think the company issuing the bond will be able to meet its obligations, or if the company suffers a blow to its reputation, the price of the bond will decrease in value, say to $800. The opposite is true if the company is a Wall Street darling. Then the bond's price will increase, maybe up to $1,200. So that's what you'll have to pay to buy the bond.

The company's stock price is a good litmus for the bond price because you can see how it's being perceived in the market. If it is disliked or there's unfavorable news about the company that's affecting the stock, that negativity will spill over and be reflected in the bond price as well.

Like their prices, bonds' yields are also in constant flux, mainly because they play off each other. Back to basic economics: When a bond's price rises, its yield drops. When its price falls, its yield rises.

So when a bond's price drops, you don't have to pay as much upfront and you get a better interest rate. You win.

Conversely, if a bond's price increases, you pay more upfront and get a lower yield.

But the connection between a bond's price and its yield can get even deeper and many will argue that the relationship between the two can be used to foretell the market.

Enter that infamous yield curve, which we'll, uh, bond with next week.

1 What would best describe your stance heading into the coming week of trading? Bullish Bearish Neutral 2 Which of these sectors do you think is set to move up in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities 3 Which of these sectors do you think is set to move down in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities View the results without voting