When you see a bond rating for a particular corporation's investments, this represents a measure of the quality of the company's debt. A bond rating is, in a way, similar to the credit rating that a person might get. There are three major companies that offer bond ratings, and they use two similar sets of criteria to help determine the quality of the credit and the debt's susceptibility to market trends.
The Ratings Makers
Standard and Poor's is probably the most recognized bond rater in the United States, and its index is a fixture on daily financial reports. Moody's is a private company that provides credit and bond rankings in more than 100 countries around the world. Moody's requires membership to gain access to its information. Fitch Ratings is another private ratings company that provides bond and investment ratings for clients around the world.
Credit Quality Ratings
Among the primary criteria used to measure bond ratings are Credit Quality Ratings, or CQRs. This rating is designed to measure how likely a fund is to withstand losses from credit defaults, according to Standard and Poor's. For instance, S&P uses the fund's history of defaults, studies on its transaction history, and an overall portfolio analysis in order to make this determination. From this analysis, S&P, along with other bond rating companies such as Moody's and Fitch, provides a rating for the fund's protection against loss.
The other major rating measures the bond's volatility. Volatility is defined as the how much the bond will fluctuate due to market conditions. To measure this, the three major bond raters look at the fund's overall strategy of investment and the risk level of its overall portfolio. Some of the factors that can influence both of these assessments include interest rates, currency risks, credit, liquidity and concentration of investments. From these factors, it is possible to determine the bond's volatility rating.
From the CQR and the volatility scores, all three bond rating companies are able to provide a ranking of the quality of the bond. The CQR score is typically a letter. S&P and Fitch use A's, B's and C's, while Moody's uses a P. The volatility score is a number from one to three. S&P and Fitch only use numbers for short-term bonds, while Moody's uses the numbers for short-term and long-term bonds. For instance, a score of AAA for a long-term bond is the best score S&P or Fitch can give for a long-term bond, while Moody's would rate that same bond Aaa. S&P and Fitch give a score of A-1+ as its best score, while Moody's best score is P-1. Any score of A is considered upper medium grade for a long-term bond. B's are considered speculative and C's are considered to carry substantial risk.
Why Bond Ratings Are Important
The ratings are important to investors for several reasons. They are designed to measure the bond's risk, which allows investors to determine its value in their portfolio. It helps investors measure the level of risk assigned to the bond. It can also give investors a window into the bond's strategy. Finally, investors can compare similar bonds to determine where their investment should be made.
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