The fact that creditors (bondholders) have precedence over owners (shareholders) does not mean that bonds are without risk. Certainly, federal bonds are the closest thing to a risk-free investment you will find, but any corporation or any other level of government has some chance of defaulting on an issue or ending up insolvent. Credit risk or default risk is the possibility that an issuer will be unable to pay off the principal or even make the interest payment. The higher an issuer's credit risk, the lower the price and the higher the yield on its bonds.
Companies such as Moody's and Standard & Poor's specialize in rating credit. These bond ratings measure quality and safety based on the issuer's financial condition. These rating services evaluate the likelihood that a debt issuer will be able to meet scheduled interest and principal payments.
The Standard & Poor's Rating Hierarchy:
- The highest ratings - AAA, AA and A - are awarded to companies with a solid, proven record of paying interest and principal in a satisfactory manner.
- BB, B, CCC and so on down the line indicate less stellar performers.
The following table provides a side-by-side comparison of Moody's and S&P's rating scales. The scale for corporate bonds is the same as that for municipal bonds. Moody's Baa rating, corresponding to S&P's BBB, represents the lowest investment-grade bonds; everything below that line is considered speculative, and issuers are expected to offer higher yields to offset the higher perceived risks.
|Moody\'s vs. Standard & Poors Bond Ratings|
|Aaa||AAA||Investment, Highest Quality||Lowest Risk|
|Aa||AA||Investment, Very High Quality||Low Risk|
|A||A||Investment, High Quality||Low Risk|
|Baa||BBB||Minimum Investment Grade||Medium Risk|
|Ba||BB||Junk, Speculative||High Risk|
|B||B||Junk, Very Speculative||Higher Risk|
|Caa||CCC||Junk, Default Possible||Higher Risk|
|Ca||CC||Junk, Default Probable||Extreme Risk|
|C||D||Junk, In actual or imminent default||Highest Risk|
For investors considering buying debt securities, a credit rating is an essential tool. Read more about the importance of credit ratings in the article What is a Corporate Credit Rating?.
InvestingDon't be fooled by the name - junk bonds may be for you if you know how to analyze them.
InvestingIs the bond you're buying investment grade, or just junk? Find out how to check the score.
InvestingA high-yield bond is a bond issued by a company with a very low credit rating.
Financial AdvisorMost of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
InvestingDespite investor distrust, rating agencies can be helpful. Just be sure you use these ratings as a starting point.
InvestingInvestment grade is a term used to describe a favorable rating for corporate and municipal bonds.
InvestingIn stressed market conditions, particularly in economic recessions, junk bonds should be examined and monitored with additional prudence.
InvestingA look at the risks, returns and ratings of different types of bonds.
InvestingA bond rating is a grade given to a bond to indicate its creditworthiness.
Financial AdvisorFind out more about these bonds that have a high risk of default.