Definition
A bond rating is a grade assigned to bonds that represents an assessment of the issuer’s creditworthiness. The rating is issued by credit rating agencies like Standard & Poor’s and Moody’s. High-rated bonds are considered low risk while lower-rated bonds are considered high risk.
Key Takeaways
- Bond Rating is a grade given to bonds that indicates their credit quality. It is assigned by a credit rating agency such as Moody’s, Standard & Poor’s or Fitch.
- Higher bond ratings (AAA being the highest) are considered low risk, indicating that the issuer has a better chance of paying back the loan. Conversely, lower ratings (D being lowest) signify a higher credit risk.
- Bond Ratings directly influence the interest rates that companies, cities, and governments pay on their bond issues. Higher-rated bonds attract more conservative investors due to lower risk, hence they generally pay lower interest rates.
Importance
A bond rating is crucial as it acts as an indicator of the credit quality of a bond, as assessed by a rating agency such as Standard & Poor’s, Moody’s, or Fitch.
This rating is based on the issuer’s financial condition and its ability to meet the bond’s payment obligations.
A higher bond rating implies a lower risk of default, attracting investors as it signifies safety of the invested capital and regular interest payments.
Conversely, a lower rating usually means higher interest rates due to the increased default risk.
Therefore, bond ratings significantly influence the interest rate that companies, institutions, or government entities will pay to borrow money, and impact investors’ decisions.
Explanation
The primary purpose of a bond rating is to provide investors with an independent evaluation of the creditworthiness of the bond issuer. These ratings are conducted by reputed credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch Ratings among others.
The rating serves as a benchmark to compare the relative risk of investing in securities across different organizations and industries. A high bond rating generally indicates a lower risk of default, making the bond attractive to investors, while a lower rating suggests a higher risk of default.
Bond ratings are extensively used by individual and institutional investors, financial institutions, and governments to make informed decisions about investing in specific bonds. The rating directly affects the interest rate that companies have to pay to attract investors.
For example, a bond with a low rating might have to offer a higher interest rate to compensate for the higher risk. Consequently, bond ratings have a significant impact on the cost of borrowing for corporations and governments.
Examples of Bond Rating
Moody’s Investment Services Bond Rating: In 2019, Moody’s upgraded Microsoft’s long-term debt rating to “Aaa”, which is the highest possible rating. It showed that Moody’s had maximum confidence in Microsoft’s ability to meet its financial commitments and suggested a very low risk of default.
Standard & Poor’s Bond Rating: In August 2011, Standard & Poor’s (S&P) downgraded the long-term U.S. credit rating from AAA (outstanding) to AA+ (excellent) for the first time in history. The downgrade reflected their opinion about the country’s fiscal challenges and uncertainties.
Fitch Ratings Bond Rating: In 2015, Fitch Ratings downgraded the long-term bond rating of Brazil from “BBB” to “BB+”, which is considered speculative or non-investment grade. This decision came after challenges faced by Brazil, including economic contraction, increased government debt, and political instability.
FAQs on Bond Rating
What is Bond Rating?
Bond rating is the credit score given to a bond that indicates its credit quality. Independent rating agencies issue these ratings, with AAA being the highest rating.
Why is Bond Rating Important?
Bond ratings are important because they convey the risk associated with investing in a bond. A bond with a high rating is considered to have lower risk than a bond with a low rating. It helps investors determine the creditworthiness of the bond issuer and potential return on investment.
Who Rates Bonds?
Bonds are rated by independent rating agencies. The most famous amongst these are Moody’s, Standard & Poor’s, and Fitch Ratings. These companies evaluate the financial strength of both corporate and governmental bonds issuers.
What Does a Higher Bond Rating Mean?
A higher bond rating means that the bond is less risky and has a higher possibility of meeting its payments. Bond ratings range from AAA (highest quality) to D (default), with seven rating levels in between.
What Happens When a Bond is Downgraded?
When a bond’s rating is downgraded, it means that the credit rating agency believes there’s an increased risk that the issuer might not meet its obligations. This can lead to a drop in its price and an increase in its yield. Also, some bond funds are required to sell bonds that have been downgraded below a certain threshold.
Related Entrepreneurship Terms
- Credit Risk
- Interest Rate Risk
- Investment Grade Bonds
- Rating Agencies
- Junk Bonds
Sources for More Information
- Investopedia: A comprehensive source that covers a wide array of financial topics, including bond ratings.
- S&P Global Ratings: One of the major bond ratings agencies. Besides general information, you can get specific bond ratings here.
- Moody’s: Another important bond-rating agency that offers a wealth of information on bond ratings.
- Fitch Ratings: A major global ratings agency providing in-depth information on bond ratings.
