Role of Credit Rating Agencies in the Capital Market

Credit rating agencies review the financial condition of corporations that issue bonds, and then assign a variable rating based on the credit risk assumed by investors who purchase a company's debt obligations.

Function

Bond rating firms help investors assess the risk of a particular corporate bond issue by determining the ability of the company to pay its annual interest obligations, as well as its ability to pay back the principal amount of the bond when it matures or comes due.

Significance

The interest rate a corporation must pay on a bond issue to compensate investors for the credit risk assumed is directly related to its designated rating.

Considerations

Corporations with the best credit-risk ratings will pay a lower interest rate than corporations with a much lower or speculative rating. The savings in interest costs can be substantial for a company with a relatively good credit rating.

Types

Though there are slight variations, most rating agencies designate bonds with the least credit risk as AAA. Bonds with the greatest risk are denoted as CCC.

Ratings May Change

The hierarchical ratings assigned to a company's bonds can change, depending on any favorable or unfavorable changes in the financial condition of the issuing corporation.

References

• Bond Rating