What Are Bond Ratings?
A bond is a loan produced using an investor to a corporation or a government entity. In return for their investment, the bondholder hopes to be reimbursed their principal, or original investment amount, along with interest, which is known as the coupon. The longer the investment period or the riskier the company they are lending money to, the greater the amount of interest the bondholder will receive.
Yet, how could investors tell how risky a bond is? All bonds receive a financial rating as a letter grade. This illustrates their creditworthiness, let investors know how likely it is that a bond will be reimbursed by its issuer. Like that, investors realize how much risk they are expecting before they make their investment.
What Do Bond Ratings Agencies Do?
To assist investors with grasping the creditworthiness of a bond, private rating agencies, like Standard and Poor's, Moody's, and Fitch Ratings, conduct an assessment of the bond issuer at the time they issue a bond. They assess the issuer's ability and readiness to make all payments in full and on time. Every agency has its own grading system, however all utilization standard metrics and are viewed as dependable sources.
What Are the Bond Ratings?
Bond ratings agencies distribute their ratings in a straightforward grading system, which incorporates the grade and risk level:
|Bond Rating||Investment Grade|
|BB||Faces major uncertainties, although less vulnerable in the near-term|
|B||Faces major uncertainties has more near-term vulnerability to adverse business|
|CC||Highly vulnerable to non-payment|
|C||Default has not yet occurred, although it is expected|
|D||Payment default, or in bankruptcy|
How Are Bond Ratings Calculated?
Rating agencies examine corporate financial statements to evaluate their credit quality. The metrics they use are proprietary, however a few factors they could think about in their statistical analysis include:
- Assets under administration
- Probable return on investment
- Debt agreements
Do Bond Ratings Change Over Time?
Indeed. Ratings are assigned when bonds are first issued and are looked into consistently. On the off chance that a ratings agency presumes that an issuer's creditworthiness has improved, it might upgrade the bond. On the other hand, assuming it reasons that an issuer's creditworthiness has deteriorated, it might downgrade.
UPS bonds, for instance, were rated AAA back in the mid 2000s, yet after the company arrived at a long-term agreement with union workers, which increased wages and benefits yet froze its pension obligations, credit ratings agencies downgraded the company to AA status.
In response to the downgrade, UPS raised its bond yields by around 0.5%, which investors didn't appear to mind. As a matter of fact, nowadays, on the grounds that not many companies earn the sought after AAA rating, downgrades are not thought of as harming to a corporate reputation as they used to be.
Why Are Bond Ratings Important to Investors?
Bond ratings are an important way for investors to comprehend the risks they are taking when they invest in a bond. It makes them aware of the quality of the bond — and why the bond might be offering a high yield. Bond ratings give investors a simple method for measuring how dependable of an investment a bond will be.
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- A bond rating is a letter-based credit scoring scheme used to judge the quality and creditworthiness of a bond.
- Investment grade bonds assigned "AAA" to "BBB-" ratings from Standard and Poor's, 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, all else equivalent.