Financial News & TipsALAN MOORE / L’Observateur / August 12, 1998Q: What are bond ratings and how do they work?
A: Bond investors want to be reasonably sure that they’ll get their interest payments on time and their principal back at maturity. It’s almostimpossible for an individual to do the necessary research. But ratingservices make a business of it.
The best-known services are Standard & Poor’s (“S&P”) and Moody’s Investor Services (“Moody’s”). These companies carefully investigate thefinancial condition of a bond issuer rather than the market appeal of its bonds. They look at other debt the issuer has, how fast the company’srevenues and profits are growing, the state of the economy, and how well other companies in the same business are doing. Their primary concern isthe ability of the issuer to meet payments on their debt obligations.
The top four categories are considered investment-grade bonds.
Investment-grade generally refers to any bonds rated Baa or higher by Moody’s, or BBB or higher by S&P. U.S. treasury bonds are not rated;however, they are assumed to be of the highest credit quality since they’re obligations of the federal government, backed by its full faith and credit.
This means the government has the authority to raise taxes to pay off its debts.
Q: Where can you open an Individual Retirement Account (“IRA”)?
A: An IRA is a trust or custodial account. As such, there must be a trustee orcustodian who is responsible for holding the assets, reporting the account activity, and generally making sure that the basic rules are followed. Inorder to further this activity, the government licenses IRA trustees and custodians. You can’t simply open an account at a bank and call it yourIRA. You must open it under approved IRA documentation offered by thebank or financial institution.
It’s important to keep in mind that an IRA trustee or custodian is not responsible for keeping you away from income tax penalties or incorrect distributions. No matter how reputable your custodian, it is yourresponsibility to know the income tax rules and how they apply in your situation. Simply because your custodian allows you to take money out ofthe account doesn’t mean that a tax penalty will not be charged to you.
IRA trustees and custodians are companies that have applied to operate in this role. They have drafted IRA documents that have been submitted toUncle Sam and set forth the rules by which the account will be handled.
The government, through the Department of the Treasury, approves the application and the documents. Why Treasury? Because there are taxesdue that are being deferred through the use of the IRA account.
Four types of companies qualify as IRA custodians: brokerage houses, mutual fund companies, insurance companies, and banks.
If you have any questions that you would like answered in this column, please write me c/o Alan S. Moore, L’Observateur, PO Box 1010, LaPlace,LA 70069.
(Alan S. Moore is a financial advisor in the New Orleans office of LeggMason Wood Walker, Inc., a diversified financial services and securitiesbrokerage firm that is a member of the New York Stock Exchange and SIPC.)
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