A bond rating indicates its credit quality and is given to a bond by a rating service. The rating considers abond issuer's financial strength or ability to pay a bond's principal and interest. Moody's, Standard and Poor's, and Fitch Ratings are well-known bond-rating agencies.
These organizations provide investors with quantitative and qualitative descriptions of the available fixed-income securities. Generally, a"AAA" high-grade rated bond offers more security and lower yield than a "B-" rated speculative bond.
Key Takeaways
Credit ratings assigned by rating services provide a bond's quality and riskiness.
Rating agencies use several metrics in determining their rating score for a particular issuer's bonds.
A firm's balance sheet, profit outlook, competition, and macroeconomic factors determine a credit rating.
Rating Bonds
Ratings are based on specific intrinsic and external influences. Internal factors include the overall financial strength rating of the financial institution. Moody's implements a scale where A corresponds with a financially healthy bank, and E resembles a weak institution. The rating depends on the firm's financial statements and corresponding financial ratios.
External influences include interested parties, such as a parent corporation, local government agencies, and systemic federal support commitments. The credit quality of these parties is researched, and a comprehensive overall external score is assigned. This grade is added to the predetermined "intrinsic score" to obtain the overall grade.
Specific bonds, such as hybrid securities, consider the underlying terms of the debt. Bond rating extends beyond simple ratio analysis and a firm's balance sheet. Different measures are used for varying industries, and external influences play a role in the intricate process. A forecast of economic conditions, statistical distribution estimates of the probability of default, and loss severity provide investors with standardizedletters to help quantify their investment.
Investment Grade Bonds
The bond rating alerts investors to the quality and stability of the bond. The rating influences interest rates, investment appetite, and bond pricing. Furthermore, independent rating agencies issue ratings based on future expectations and outlooks.
Higher-rated bonds, investment-grade bonds, are safer and more stable investments tied to corporations or government entities. Investment-grade bonds contain “AAA” to “BBB-“ ratings. Bond yields increase as ratings decrease. Most common "AAA" bond securities have been historically found in U.S. Treasury Bonds.
In August 2023, Fitch Ratings downgraded the long-term ratings of the United States to "AA+" from "AAA" based on the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to "AA" and "AAA" peers over the last two decades with repeated debt limit standoffs and untimely resolutions.
Junk Bonds
Non-investment grade bonds or “junk bonds” usually carry ratings of “BB+” to “D” or “not rated.” Bonds with these ratings are seen as higher-risk investments that can attract investor attention through their high yields. Investors of junk bonds should know the risks of investing in bonds issued by companies with liquidity issues.
Fallen Angel: This was an investment-grade bond but has since been reduced to junk-bond status because of the issuer's poor credit quality.
Rising Star: The opposite of a fallen angel, this is a bond with a rating that has been increased because of the issuer's improving credit quality. A rising star may still be a junk bond but is on its way to investment quality.
Is a Bond Rating Similar to an Investor's Credit Report?
Similar to an individual's credit report and rating issued by credit bureaus, bond issuers are evaluated by rating agencies to assess their creditworthiness.
How Do Individuals Invest in Bonds?
Investors can purchase individual bonds or invest in a bond fund through a financial entity or institution such as Vanguard or Fidelity.
Why Do Lower Rated Bonds Have a Higher Yield?
Lower-rated bonds generally offer higher yields to compensate investors for the additional risk.
The Bottom Line
Credit ratings, assigned by rating services such as Moody's, Standard and Poor's, and Fitch Ratings, are important metrics of a bond's quality and riskiness. Rating agencies consider a bond issuer's financial health and ability to pay a bond's principal with interest. The rating organizations provide investors with grades, such as "AAA" or "B-" that indicate whether a bond offers more security and lower yield or is more speculative.
Standard & Poor's and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Currently there are only two companies in the United States with an AAA credit rating: Microsoft and Johnson & Johnson.
https://en.wikipedia.org › wiki › Bond_credit_rating
are expressed as letters ranging from “AAA”, which is the highest grade, to “D”, which is the lowest grade. Different rating services use the same letter grades, but use various combinations of upper- and lower-case letters and modifiers to differentiate themselves.
The credit quality of these parties is researched, and a comprehensive overall external score is assigned. This grade is added to the predetermined "intrinsic score" to obtain the overall grade. Specific bonds, such as hybrid securities, consider the underlying terms of the debt.
Bonds with a rating of BBB- (on the Standard & Poor's and Fitch scale) or Baa3 (on Moody's) or better are considered "investment-grade." Bonds with lower ratings are considered "speculative" and often referred to as "high-yield" or "junk" bonds.
'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.
The highest-quality bonds are rated Aaa at Moody's and AAA at S&P and Fitch, with the scales declining from there. Moody's ratings of Baa3 and BBB at S&P and Fitch are considered the lowest investment-grade ratings. Ratings below this are considered high-yield or junk.
AAA and Aaa ratings are considered to be investment grade. Since they are perceived to have the lowest risk of default, these instruments tend to offer the investors the lowest yields among bonds with similar maturity dates (lower risk equals lower return).
Companies with these ratings are considered to be stable entities with robust capacities for repaying their financial commitments. However, such companies may encounter challenges during deteriorating economic conditions. The bottom tier of investment grade credit ratings delivered by Standard and Poor's include: BBB+
Bonds with triple-A ratings are considered the safest investments available. As you scan down the chart, credit quality decreases and risk increases. Debt rated below BBB- will pay a higher rate of interest to the bondholder but will also come with a much greater risk of default.
'aa' ratings denote very strong prospects for ongoing viability. Fundamental characteristics are very strong and stable, such that it is considered highly unlikely that the financial institution would have to rely on extraordinary support to avoid default.
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.
Junk bonds, on the other hand, are rated below BBB and carry what is considered the highest risk of a company missing an interest payment (called default risk).
Use Bloomberg (see Bloomberg Guide).Type the ticker symbol of the company you want, hit the yellow <CORP> key, then type CRPR and hit . Bonds are listed by Bloomberg composite ratings. Bloomberg also offers its own proprietary rating which can be found using the DRSK function.
Buying individual bonds can provide increased control and transparency, but typically requires a greater commitment of time and financial resources. Investing in bond funds can make it easier to achieve broad diversification with a lower dollar commitment, but offers less control.
Most corporates typically have more credit risk and higher yields than government bonds of similar maturities. This divergence creates a credit spread between corporates and government bonds, so that the corporate bond investor earns extra yield by taking on greater risk.
Key Takeaways. The price of a bond is determined by discounting the expected cash flows to the present using a discount rate. The three primary influences on bond pricing on the open market are supply and demand, term to maturity, and credit quality.
Financial Indicators: Rating agencies examine financial variables to determine the creditworthiness of a company. Financial statements, cash flow analysis, debt ratios, profitability measurements, and liquidity measures are a few examples of these indicators.
'AAA' ratings denote the lowest expectation of default risk. They are assigned only in cases of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events.
Introduction: My name is Allyn Kozey, I am a outstanding, colorful, adventurous, encouraging, zealous, tender, helpful person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
:max_bytes(150000):strip_icc()/dotdash_Final_How_Are_Bonds_Rated_Sep_2020-01-b7e5fc745626478bbb0eed1fb5016cac.jpg "How Are Bonds Rated? (1)")
