Finance

How Are Bonds Rated?

How Are Bonds Rated?

Bond-rating represents the creditworthiness of government or corporate bonds. The ratings are given by credit rating agencies. The big three credit rating agencies are S&P, Fitch, and Moody. 95% of the ratings are given by these three rating agencies. It is an opinion of a particular credit agency regarding the ability and willingness of an entity to fulfill its obligations. Credit rating is used by the investment professionals to access that whether the debt would be repaid or not. The information mentioned below shows How Are Bonds Rated?.

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Agency those assess bond risk?

The three bond rating agencies are S&P, Moody, and Fitch in the U.S. Every agency uses their different letter-based rating to rate the bond whether that carries a low or high default risk and is the issuer financially stable. Each uses a unique letter-based rating system to quickly convey to investors whether a bond carries a low or high default risk and whether the issuer is financially stable. The agencies rate the bonds at the time they are issued and the bonds are rechecked again that whether the ratings should be changed or should be the same. Standard and poor’s highest rating is AAA and when the bond reaches BB+, it enters the non-investment grade category and the lowest rating is D, which is the default. Moody assigns the bond rating as AAA, Aa, A, Baa, Ba, B, Caa, Ca, C, with WR and NR as withdrawn and not rated, respectively. Standard & Poor’s and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, and D. Here, D denotes a bond issuer in default.

Bond Rating Scale:

Moody S&P Fitch Grade
Aaa AAA AAA Investment
Aa AA AA Investment
A A A Investment
Baa BBB BBB Investment
Ba BB BB Non-Investment
B B B Non-Investment
Caa CCC CCC Non-Investment
Ca CC CC Non-Investment
C C C Non-Investment
D D D Default

 

What do these ratings indicate?

Bond-rating is a grade given to bonds that indicate their credit quality. Up till BBB or Baa ratings the grade is investment grade and after which it is known as non-investment or speculative-grade (also known as junk grade) and then D represents default. The ratings of Fitch and S&P are similar whereas Moody’s rating is a unique- letter-based rating. Within the investment-based category, firms have the capacity to meet their obligation, and non-investment grade categories indicate considerable capacity and uncertainty issues.

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Factors That Affect Bond Rating:

  • Creditworthiness – The Biggest factor that affects the bond rating is the credit risk of the company. Credit risk is the ability of the company to repay the debt to its creditors. If the creditworthiness of the company decreases the bond rating falls.
  • Future performance – The credit rating agencies look back to the history of the company and well the company performed in the past. The company demonstrates that its current financial stability is not likely to change shortly and then those companies receive a high credit rating.
  • Corporate events – There are two types of corporate events – positive and negative. A positive corporate event is the launch of a new product and a corporate scandal is a negative event. Credit rating agencies take these events into consideration while giving ratings. Positive corporate events get a high credit rating and negative events get a low credit rating.

Final Thoughts:

Credit ratings are very important for investors to invest in a particular company. If the credit ratings are given systematically, the investing market will become a safe place. Hence, credit rating agencies play a very important role in rating bonds. Investors should not invest in any company before visualizing the credit rating of a particular company. They should also self-study the company and not just rely on the bonds rated. But it’s is equally important for the company to maintain a good credit rating throughout and repay the debt on time so that the investors can freely invest in their companies.

Author Saachi Lodha

About the Author – A passionate professional with knowledge of Accounting and Finance and currently exploring Financial Risk Management (FRM) to gain knowledge and exposure. As a part of the FRM course also writing blogs to explore the field more and deep dive into the content.

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