The key distinction
Government bonds (specifically US Treasuries) are considered risk-free from a credit standpoint — the US government can print dollars to repay dollar-denominated debt. They carry only interest rate risk. Corporate bonds carry both interest rate risk AND credit risk — the company might default.
The yield premium that corporate bonds pay over equivalent-maturity Treasuries is the credit spread. This spread compensates for: probability of default, recovery rate if default occurs, liquidity risk (corporate bonds are less liquid than Treasuries), and call risk (many corporate bonds can be repaid early).
Investment-grade (IG) corporate bonds are rated BBB- or above by S&P/Fitch, or Baa3 or above by Moody's. High-yield (HY) bonds are below those thresholds. The distinction matters because many institutional investors (pension funds, insurance companies) have mandates to hold only investment-grade — a "fallen angel" (IG bond downgraded to HY) forces mandatory selling.
LQD is the iShares IG Corporate Bond ETF; HYG is the iShares HY Corporate Bond ETF. The spread between their yields is a real-time credit risk indicator. Both ETFs can be traded like stocks and provide direct corporate bond market exposure without OTC access.
Credit rating agencies
Moody's, S&P, and Fitch are the three major credit rating agencies. They assess the creditworthiness of bond issuers and assign ratings that guide institutional capital allocation. Ratings matter enormously: investment-grade designation provides access to a much larger buyer base at lower yields.
Rating changes are market events. An upgrade from HY to IG (a "rising star") causes institutional buyers to step in, often sharply tightening spreads. A downgrade from IG to HY (a "fallen angel") forces mandatory selling from IG-only investors, widening spreads — often significantly.
Rating agencies have been criticized for being lagging indicators (they downgraded mortgage securities in 2008 after the crisis was apparent) and for conflicts of interest (issuers pay for ratings). The market's own pricing of credit risk (through CDS spreads) often moves well before rating agencies act.
Sector dynamics in corporate credit
Different corporate sectors have different credit profiles. Utilities have predictable cash flows and low volatility — their bonds trade with tight spreads. Commodity-linked companies (energy, mining) have cyclical, volatile earnings — their spreads widen dramatically in downturns and compress in upswings.
Financial sector bonds (banks, insurance companies) are uniquely sensitive to credit crises because these companies are at the center of financial intermediation. Bank bond spreads widening significantly is a serious systemic warning signal — it was one of the clearest advance signals of 2008.
Monitoring sector-level spread trends (available from Bloomberg, ICE BofA indices) allows traders to identify where credit stress is emerging before it shows in equity prices. Energy credit widening before energy equities sell off, or financial credit widening before bank stocks move, gives actionable advance notice.