Most investors categorize bonds as “safe” and stocks as “risky.” This binary view often overlooks the specific mechanics of the corporate bond market, where the risk isn’t always about a company going bankrupt. Instead, the true risk often lies in the “spread”—the extra yield investors demand over risk-free government Treasuries.
In a stable economy, this spread is thin. But when market sentiment shifts, corporate bonds can behave with a volatility that mimics the equity markets.
The collapse of Silicon Valley Bank (SVB) in early 2023 served as a masterclass in credit risk perception. Before the crisis, investment-grade financial bonds were trading at narrow spreads. Within days, the spread on the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) widened significantly. Investors weren’t just worried about interest rates; they were suddenly pricing in the “risk of the unknown” across the entire banking sector.
Credit quality is a sliding scale, not a fixed label.
The boundary between “Investment Grade” (IG) and “High Yield” (HY) is the most critical divide in the bond world. Bonds rated BBB—the lowest tier of investment grade—represent a massive portion of the market. Companies like Ford (F) and Occidental Petroleum (OXY) have famously drifted across this line, becoming what traders call “Fallen Angels.”
When a company is downgraded from BBB to BB (High Yield), it is often forced out of institutional portfolios that are mandated to hold only investment-grade debt. This creates a “forced selling” event.
In 2020, at the onset of the pandemic, Ford was downgraded to junk status. The result was a violent price drop that had nothing to do with the company’s long-term ability to pay its debts, and everything to do with the mechanical structure of bond indexes. For the disciplined investor, these forced liquidations often represent the best entry points in the fixed-income market.
Yield is your compensation for two distinct risks.
When you buy a corporate bond from a giant like Verizon (VZ), the yield you receive is the sum of the risk-free rate (Treasury yield) plus the credit spread. If the 10-year Treasury is at 4.2% and Verizon pays 5.5%, your “spread” is 1.3%.
If Verizon’s business struggles, that spread might widen to 2.5%. Even if government interest rates stay the same, the price of your Verizon bond will fall because the market now demands a higher premium for the risk of holding Verizon’s debt.
This is why corporate bonds can lose money even when the Federal Reserve is cutting rates. If a recession looms, the “spread widening” can outpace the “rate falling,” leading to negative total returns.
Liquidity is the hidden trap.
Unlike the stock market, where millions of shares of Apple (AAPL) trade every hour, individual corporate bonds are often illiquid. Many bonds trade only a few times a week, or not at all.
In times of stress, the gap between the “bid” (what you can sell for) and the “ask” (what you can buy for) explodes. During the 2022 market downturn, many investors in the SPDR Bloomberg High Yield Bond ETF (JNK) found that while the ETF was easy to trade, the underlying bonds were nearly impossible to price accurately.
This liquidity premium is a risk that doesn’t appear on a balance sheet but shows up instantly in a crisis.
The “Covenant Lite” era has changed the safety net.
Historically, bondholders were protected by “covenants”—legal requirements that forced companies to maintain certain financial health ratios. Over the last decade, the rise of “covenant-lite” lending has stripped many of these protections away to the benefit of issuers like Carnival Corp (CCL) or various Private Equity-backed firms.
For the investor, this means that a company can deteriorate much further than in the past before a “default” is triggered. You may find yourself holding a bond in a company that is fundamentally broken, yet technically not in default, leaving you with a “zombie” asset that trades at 40 cents on the dollar.
Ultimately, corporate risk is about the “Capital Stack.”
In the event of a restructuring, bondholders sit above stockholders. When Hertz went through bankruptcy in 2020, the stockholders were initially thought to be wiped out, while bondholders fought over the remaining assets. Understanding where your specific bond sits—whether it is “Senior Secured” (first in line) or “Subordinated” (last in line)—is more important than the headline yield.
In the corporate world, risk isn’t just about losing everything. It’s about the volatility of the spread, the trap of illiquid markets, and the strength of the legal contract.
FAQ
What is a “Fallen Angel” in the bond market? A company that was previously rated Investment Grade but has been downgraded to High Yield (Junk) status.
Why do corporate bonds move more than Treasuries? They are sensitive to both interest rate changes AND the perceived economic health (credit risk) of the company.
Does a higher yield always mean higher risk? Generally, yes. It reflects the “premium” the market demands to take on the specific credit, liquidity, or duration risks of that issuer.
What happens to my bond if a company goes bankrupt? As a bondholder, you are a creditor. You have a legal claim on the company’s assets that must be satisfied before stockholders receive anything.
What is LQD? It is a popular ETF that tracks a broad index of liquid, U.S. dollar-denominated, investment-grade corporate bonds.