Bond Ratings Guide - How Do The Ratings Work?
As an investor in bonds, you should be concerned about bond ratings for many reasons that will be discussed later. Suffice it to say that, once you have understood the importance of looking at the bond's credit rating, you are lessening your risks for investing in bonds with the highest potential to lose money for their holders. Reasons to Look at Ratings We can name many but because of space limitations, we shall limit ourselves to just two. For one thing, a bond rating provides for the best assessment of the credit worthiness of the issuing entity, be it a private corporation or a public agency of the government. Keep in mind that the credit rating for a bond issue is not given lightly by the credit rating agencies like Moody's. Comprehensive technical and fundamental research on past performance, present status and future outlook are done on the issuer before bond ratings are given for the bond issue. The research is so thorough that companies may squirm under such close scrutiny. For another thing, the ratings on bonds are more reliable than those assigned to stocks - buy, hold, sell - by analysts in the market. This is because bonds have a more predictable nature by virtue of their associated interest rate and a set maturity date. As such, many mathematical tools can be used to forecast the future yields and prices of the bonds, which is nearly impossible with most other investments like stocks. You are then able to predict with a substantial degree of certainty the outcome of your bond investment. Just look for the bonds with high bond ratings such as AAA to BBB-minus. Bond Ratings ProvidersThe next question then is: Who provides for these ratings on bond quality? In the investment world, there are only three of the most highly-respected credit rating agencies, namely, Moody's, Standard & Poor's, and Fitch's. In an aside, Standard & Poor's was the credit rating agency that downgraded the United States' sterling rating from AAA to AA-plus ostensibly because of Congress' inability to act on important matters related to the budget and its deficit. The downgrade sent jitters down investors' spine especially for those in overseas locations because it represented a loss of faith, so to speak, in the US government's supreme ability to pay all its outstanding debts. Moody's have the largest database of ratings with over 19,000 long-term issues; 28,000 municipal bonds; and 2,000 commercial paper issues. Standard & Poor's have approximately 2,000 domestic and overseas companies; 8,000 government agencies; and 1,300 commercial entities under its roster. Examples of Bond RatingsAnyways, these three agencies use an alphanumeric system to give bond ratings to private and public corporations. Just to give examples of these ratings and what each one means (take note that we are using Moody's rating system with the S&P's system in parenthesis with Fitch also using the latter in most ratings):
In conclusion, these bond ratings are, indeed, good ways to determine if the bonds being issued are good investments.
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