The Role of Credit Rating Agencies in Structured Finance Markets
Credit rating agencies play a key role in the economy. They analyze financial data and rate risks implicit in corporate activities. Structured finance products help firms hedge (protect against) financial risks.
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Credit Rating Agency Defined
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A credit rating agency, also known as a rating agency, applies math-based formulas and statistical tools to analyze a company's financial information and rate its debt as "junk" or "investment-grade." A "junk" bond is a risky asset. Investment-grade is the opposite of junk.
Function
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A rating agency helps an investor measure credit risks implicit in a company's activities. Credit risk is the loss probability arising from a borrower's default due to bankruptcy.
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Structured Finance Product Defined
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A structured finance product is a debt security with multiple features, such as risk levels, maturity dates and investment strategies. For example, a structured asset may combine junk and investment-grade products.
Structured Finance Market Significance
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The market for structured products is larger than the market for traditional assets, such as bonds or stocks. This is due to the fact that structured assets may be hybrid assets, combining both equity and debt features.
Credit Rating Agency Role
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Credit rating agencies help investors make sound and well-informed asset-selection decisions, because they provide inside into the loss expectation related to structured finance products. For example, an investor buying a junk bond is aware of the bond risk measure.
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References
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