Definition of an Investment Grade Debt
Corporations and government entities that issue debt in the form of bonds, bills and notes are given credit ratings by several rating agencies. Although there is a range of credit ratings, bond issuers and their debt can be broadly categorized as either investment grade or non-investment grade. Understanding the difference is very important for bond investors.
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Function
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Debt issuers are evaluated for their ability to repay borrowed money, and they are given credit ratings by the major rating agencies. The most common ratings are from Standard & Poor's, Moody's and Fitch Ratings. Each agency rates a little differently, but the ratings start with AAA or Aaa as the highest and work down through AA, A, BBB and so on until the lowest rating, D. The different agencies use uppercase or lowercase letters and might add a plus or minus sign to add intermediate credit ratings. For example, A+ is a credit rating just slightly better than A. Moody's credit ratings always uses a small "a" for subsequent letters; for example, Baa, Caa, Ca.
Identification
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Investment grade debt has a credit agency rating of BBB, Baa or higher. Investment grade bonds can have ratings of BBB, A, AA and AAA. Bonds rated BB+ and lower are non-investment grade. Non-investment grade bonds often go by the terms high-yield and junk bonds.
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Significance
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The higher a company's credit rating, the lower the interest rate it can pay to borrow money through issuing debt. Many investment portfolios and mutual funds are required to buy only investment grade debt. If a company's debt is downgraded to non-investment grade, the rate of interest jumps significantly from what the rate was with investment grade rating. Corporations want to have the highest credit rating possible, to lower their cost of borrowing money.
Considerations
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Debt that carries an investment grade rating is considered by investors to have a high probability to pay the scheduled interest and principal amount at maturity. Non-investment grade bonds have a significantly higher probability of default, according to Schwab.com.
The credit rating of bond issuers can change as their financial condition changes. The cutoff between investment grade and non-investment grade bonds has been proven to show a higher level of safety for investment grade bonds.
Exception
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One type of bond or debt that is not given a credit rating is debt from the U.S. government. U.S. Treasury debt is not rated by the rating agencies, but it is considered to be the highest level of investment grade debt. Treasury debt is the benchmark for safety and bond interest rates.
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References
- Photo Credit debt defined image by Christopher Walker from Fotolia.com
