What Is a Bond Rating?
A bond rating is a way to measure the creditworthiness of a bond, which corresponds to the cost of borrowing for an issuer. These ratings typically assign a letter grade to bonds that indicate their credit quality. Private independent rating services such as Standard & Poor's, Moody’s Investors Service, and Fitch Ratings Inc. evaluate a bond issuer's financial strength, or its ability to pay a bond's principal and interest, in a timely fashion.
Key Takeaways
- A bond rating is a letter-based credit scoring scheme used to judge the quality and creditworthiness of a bond.
- Investment grade bonds are assigned “AAA” to “BBB-" ratings from Standard & Poor's and Fitch, and "Aaa" to "Baa3" ratings from Moody’s. Junk bonds have lower ratings.
- The higher a bond's rating, the lower the interest rate it will carry, due to the lower risk, all else equal.
- The bond rating agencies rate all types of bonds, from corporate bonds to sovereign bonds.
Understanding Bond Ratings
Most bonds carry ratings provided by at least one of the following three chief independent rating agencies:
- Moody's Investors Service
- Fitch Ratings Inc.
To determine a bond's rating, these agencies conduct a thorough financial analysis of a bond's issuing body, whether they are U.S. Treasuries or bonds from international corporations.
Based on each agency’s individual set of criteria, analysts determine the entity’s ability to pay their bills and remain liquid, while also taking into consideration a bond's future expectations and outlook. The agencies then declare a bond's overall rating, based on the collection of these data points.
Pricing, Yield, and a Reflection of Long-Term Outlook
Bond ratings are vital to alerting investors to the quality and stability of the bond in question. These ratings consequently greatly influence interest rates, investment appetite, and bond pricing.
Higher-rated bonds, known as investment-grade bonds, are viewed as safer and more stable investments. Such offerings are tied to publicly traded corporations and government entities that boast positive outlooks.
Investment grade bonds contain “AAA” to “BBB-" ratings from Standard and Poor's and Fitch, and "Aaa" to "Baa3" ratings from Moody’s. Investment-grade bonds usually see bond yields increase as ratings decrease. U.S. Treasury bonds are the most common AAA-rated bond securities.
Non-investment grade bonds (junk bonds) usually carry ratings of “BB+” to “D” for Standard and Poor's and Fitch, and "Baa1" to "C" for Moody’s. In some cases, bonds of this nature are given “not rated” status. Although bonds carrying these ratings are deemed to be higher-risk investments, they nevertheless attract certain investors who are drawn to the high yields they offer. Some junk bonds are saddled with liquidity issues, however, and can feasibly default, leaving investors with nothing.
In Aug. 2023, Fitch Ratings downgraded the long-term ratings of the United States to "AA+" from "AAA" due to the anticipated fiscal deterioration over the next three years, increasing government debt burden, and the erosion of governance related to "AA" and "AAA" rated peers over the last two decades that has resulted in repeat debt limit standoffs and 11th-hour resolutions.
Role of the Rating Agencies in the 2008 Financial Crisis
Many Wall Street watchers believe that the independent bond rating agencies played a pivotal role in contributing to the 2008 economic downturn. In fact, it came to light that during the lead-up to the crisis, rating agencies were bribed to provide falsely high bond ratings, thereby inflating their worth. One example of this fraudulent practice occurred in 2008 when Moody's downgraded 83% of $869 billion in mortgage-backed securities, which were given a rating of "AAA" just the year before.
In short: long-term investors should carry the majority of their bond exposure in more reliable, income-producing bonds that carry investment-grade bond ratings. Speculators and distressed investors who make a living off of high-risk, high-reward opportunities, should consider turning to non-investment grade bonds.
Why Do Bonds With Lower Ratings Have Higher Yields?
Bonds with lower ratings have a greater risk of default than bonds with higher ratings. These bonds tend to have higher yields so as to still be able to entice investors, despite bringing greater risk.
What Is a Junk Bond?
Bonds that are non-investment grade are considered to be high-yield or "junk" bonds. They are considered to be high-risk and usually have ratings of "BB+" to "D" or not rated. Investors can profit through buying junk bonds, but they also are at greater risk of losing their investment, as these kinds of companies tend to have liquidity issues.
What Is an Investment Grade Bond?
An investment-grade bond is a so-called high-quality or low-risk bond. It is considered to be a fairly safe bet and has a very low rate of default. Bonds rated "AAA," "AA," "A," and "BBB" are considered investment grade.
The Bottom Line
A bond rating is a grading given to a bond that indicates its creditworthiness. Bond ratings are assigned by agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, and reflect an analysis of the bond issuer's financial strength or capacity to pay a bond's principal and interest.
The rating organizations assign grades to the bond, such as "AAA," which indicates lower risk, or "B-," which indicates greater risk. Higher-risk bonds offer higher yields, while lower-risk bonds offer lower yields.
FAQs
A bond rating is a grading given to a bond that indicates its creditworthiness. Bond ratings are assigned by agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, and reflect an analysis of the bond issuer's financial strength or capacity to pay a bond's principal and interest.
What are the bond ratings agencies? ›
There are 3 main ratings agencies that evaluate the creditworthiness of bonds: Moody's, Standard & Poor's, and Fitch.
What is a bond rating quizlet? ›
bond rating is indicator of default risk, so the rating has a direct, measurable influence on the bond's interest rate and firm's cost of borrowing.
What do bond ratings affect? ›
The bond rating alerts investors to the quality and stability of the bond. The rating influences interest rates, investment appetite, and bond pricing.
How do rating agencies describe their ratings? ›
Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. Typically, ratings are expressed as letter grades that range, for example, from 'AAA' to 'D' to communicate the agency's opinion of relative level of credit risk.
What do bond ratings mean? ›
A bond rating is a grading given to a bond that indicates its creditworthiness. Bond ratings are assigned by agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, and reflect an analysis of the bond issuer's financial strength or capacity to pay a bond's principal and interest.
What are the three rating agencies? ›
The rating agencies
Credit ratings are predominantly provided by three main independent rating agencies, namely; Standard & Poor's (S&P), Moody's Investor Services (Moody's), and Fitch IBCA (Fitch), although there are others.
What are bond ratings and why are they important in Quizlet? ›
Through bond ratings investor can see quality of the bond and that rating is based on the ability of the issuer to pay debt, ability to pay a timely principal and interest and issuers chance of default.
What is a bond rating and how does it affect interest rates? ›
Understanding Bond Ratings
The higher a bond's letter rating rating, the lower the interest rate coupon needs to be because the issuer has a lower risk of default. Conversely, the lower a bond's rating, the more interest an issuer needs to pay to incentivize investors to buy.
How does a bond's rating affect its price? ›
The ratings signal to investors the agency's view of the issuer's ability to pay the interest and principal when due. If a bond's credit rating is downgraded, the bond becomes less attractive to investors and its price will likely fall. The age of a bond relative to its maturity date can affect pricing.
The bond rating is an important process because the rating provides information for investors as to the quality and stability of the bond. The rating greatly influences interest rates, investment appetite, and bond pricing. The independent rating agencies issue their ratings based on future expectations and outlook.
How to look up bond ratings? ›
Use Bloomberg (see Bloomberg Guide).
- Type the ticker symbol of the company you want, hit the yellow <CORP> key, then type CRPR and hit . ...
- To access ratings from Fitch, Moody's or Standard & Poor's on the terminal, type the ticker symbol, hit the F8 Equity key, type CRPR, and hit the green <Go> key.
Credit rating agencies, such as Standard & Poor's, Moody's, and Fitch Ratings, analyze various factors, including an issuer's financial health, economic conditions, political and regulatory environment, and management and corporate governance, to determine the creditworthiness of a bond issuer.
What is the importance of rating agencies? ›
Rating agencies are institutions that assess the financial strength of large-scale borrowers – usually companies or governments. They particularly analyze and rate their ability to meet their debt obligations.
How do rating agencies make money? ›
How Credit Bureaus Make Money. Credit bureaus make money by selling information like consumer credit reports and data analytics to other companies. Your credit report also includes personal information like your name, birthdate, address, and Social Security Number (SSN).
What is the highest bond rating? ›
Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, as well as WR and NR for 'withdrawn' and 'not rated' respectively. Standard & Poor's and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D.
What are Moody's and S&P ratings? ›
What do S&P, Fitch and Moody's Ratings Mean?
| Moody's | S&P |
|---|
| Ungefähre Umschreibung | Long Term | Long Term |
|---|
| Investment grade: Highest (Triple A) | Aaa | AAA |
| Investment grade: Very high | Aa1 | AA+ |
| Aa2 | AA |
18 more rowsThe credit rating is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such as Moody's, Standard & Poor's, and Fitch Ratings to have letter designations (such as AAA, B, CC) which represent the quality of a bond.
What is the difference between Moody's and S&P ratings? ›
Both ratings are roughly similar, but Moody's uses both letter cases and numbers in its ratings where Standard & Poor's uses all uppercase letters along with plus or minus symbols. The highest tier of ratings identify investment grade bonds, which are very stable investments but offer low performance yields.
Which rating is better, BB or BBB? ›
'BBB' National Ratings denote a moderate level of default risk relative to other issuers or obligations in the same country or monetary union. 'BB' National Ratings denote an elevated default risk relative to other issuers or obligations in the same country or monetary union.
