Which statement best describes investment grade bonds compared to junk bonds?

• A. Investment grade bonds have high credit ratings, lower risk, and steadier cash flows; junk bonds have low credit ratings, higher risk of default, and higher interest rates.
• B. Investment grade bonds have higher yields than junk bonds.
• C. Junk bonds have higher priority in liquidation.
• D. Investment grade bonds are always short term.

Answer: (A)

Understanding this question hinges on how credit quality relates to risk and return in bonds. Investment-grade bonds carry high credit ratings, meaning issuers are less likely to default, which leads to steadier and more predictable cash flows. Junk bonds are lower-rated and come with higher default risk, so investors demand higher yields to compensate for that risk. That contrast makes the statement describing investment-grade bonds as having high ratings, lower risk, and steadier cash flows, while junk bonds have low ratings, higher default risk, and higher interest rates the best fit. The other ideas conflict with this fundamental risk–return pattern: yields on investment-grade bonds are not higher than those on junk bonds; liquidation priority is not inherently higher for junk bonds; and investment-grade bonds can be short-, medium-, or long-term, not always short-term.