What to watch out for

The risk of default

If the bond is a debt security issued by a bank or guaranteed non-bank "deposit taker" (such as some finance companies) and it expires before October 2010, you may have no real risk of default. That's because the bond may be covered by the government's retail deposit guarantee scheme (always check before investing).

If that isn't the case, then default is a possibility. In the current state of economic turmoil five years is a long time - and many of the new bonds have been issued for 5-year terms.

In some cases, even if the company goes into default, you may not be badly affected. It depends on what type of bond you have.

Not all lenders are equal

If you have a "senior" bond, rather than a "subordinated" one, and the company goes into default, you have first access to whatever funds are available to creditors. So you might get all your money back.

If you invest in a subordinated bond, banks and other investors that hold senior bonds, or are senior-ranking creditors, will have more rights than you in the case of default. And unless it specifically says so in the prospectus, there's nothing to stop companies arranging more senior debt later - pushing you further down the creditor queue.

Tip: Don't rely on the name of the security for finding out whether your bond's status is "senior" or "subordinated" or has other conditions attached - take a look at the prospectus. But even then you (or your adviser) might need to get advice from a commercial lawyer.

Rated vs unrated

Companies issuing bonds can be rated by agencies like Standard and Poor's or Moody's. This involves assessing the creditworthiness of the company and/or the securities it issues. The agency does this for a fee and at the request of the company.

The agency gives the company or bond an investment grade rating if it's assessed as having a relatively low risk of default. Bonds with a Standard and Poor's rating from BBB- to AAA are investment grade, with BBB- bonds being "more subject to adverse economic conditions".

But ratings' agencies are not always right: Macquarie Generator (Commodity) Bonds came with an investment grade rating but were still a disaster for investors (see "Other bonds").

Not all companies choose to get a credit rating. Their bonds are "unrated" and you only have your own analysis, or your adviser's, to go on.

Other checks

As well as the credit rating, you (or your adviser) need to make a judgement on how well the company will do over the life of the bond. This involves looking at the prospects for the business the borrower is in, the track record of its management, and what the company intends to do with the money it raises.

This means much more than a quick read of the investment statement. The prospectus and the financial statements also must be looked at. These give much more detail about the prospects of the company - and, for unrated bonds, this information is all you have to go on.