How Are Ratings of Bonds Determined?
A bond rating is determined by examining the profits, management and products of a company. Companies with good credit will have highly rated bonds. Get lower rates of return on highly rated bonds with insight from an investments manager in this free video on investing.
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So how are ratings of bonds determined? Well, bonds are debt instruments. The company is, in essence, putting out the offer for a loan out on the market, and whether it be the government or a corporation, when the bond is rated, they look at what the debt is against. So if it's a very solid company, good management, they're profitable, their products are solid, there's really no concerns, the bond will be highly rated. With a highly-rated bond, and going back a little bit to say that the bond's highly rated means that the company is seen to have good credit. They're going to pay off that bond. If it's good credit, they will...the bond will pay a lower amount of interest. A lot of people look for very high-rating or high-paying bond or a high interest rate, and that rate will be with a company that maybe isn't...it may be well-managed, but they may have some problems, may have some troubles, may have some things they're up against and their credit rating is a little lower. So it's just like a person borrowing for a home or a car. If your credit rating is lower, you'll get a higher interest rate to pay that loan back. And the same thing with a bond: If the company is highly rated with a good credit rating, it'll be a low rate of return. If it's a low credit rating, there'll be a much higher interest rate and you're being paid that extra amount to take on that risk.