Loading the player...

What is a 'Bond Rating'

A bond rating is a grade given to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody's Investors Service and Fitch Ratings Inc. provide these evaluations of a bond issuer's financial strength, or its the ability to pay a bond's principal and interest in a timely fashion.

BREAKING DOWN 'Bond Rating'

Most bonds carry a rating provided by one of the three independent rating agencies: Standard & Poor's, Moody’s, and Fitch. From U.S. Treasuries to international corporations, these agencies conduct a thorough financial analysis of the entity that is issuing the bond. Based on each rating agency’s individually set criteria, analysts determine the entity’s ability to pay their bills and remain liquid and assign a credit rating to the bond.

Bond Ratings Affect Pricing, Yield, and a Reflection of Long-Term Outlook

The bond rating is an important process because the rating alerts investors to the quality and stability of the bond. That is, the rating greatly influences interest rates, investment appetite, and bond pricing. Furthermore, the independent rating agencies issue ratings based on future expectations and outlook.

Higher rated bonds, known as investment grade bonds, are seen as safer and more stable investments that are tied to corporations or government entities that have a positive outlook. Investment grade bonds contain “AAA” to “BBB-“ (or Aaa to Baa3 for Moody’s rating scale) ratings and will usually see bond yields increase as ratings decrease. Most of the most common "AAA" bond securities are in U.S. Treasury Bonds.

Non-investment grade bonds or “junk bonds” usually carry ratings of “BB+” to “D” (Baa1 to C for Moody’s) and even “not rated.” Bonds that carry these ratings are seen as higher risk investments that are able to attract investor attention through their high yields. However, investors of junk bonds should note the implications and risks that are involved with investing in bonds that are issued by companies with liquidity issues. A good example of non-investment grade bond can be seen with the S&P's stance on Southwestern Energy Company, which was given a rating of "BB+" bond rating and negative outlook.

Independent Rating Agencies Get Tripped Up In 2008 Downturn

Looking back to one of the worst recessions in recent times, many people believe that the independent bond rating agencies played a pivotal part in the 2008 downturn. As the investment world has learned in the years since the crisis, the rating agencies were being paid to provide higher bond ratings, thereby giving the bonds more worth, in exchange for illegal forms of payment. One prime example of their destructive policies during the 2008 recession can be determined by Moody's downgrade of 83% of $869 billion in mortgage-backed securities that were given a rating of "AAA" just the year before.

In short, long-term investors should carry the majority of their bond exposure in more reliable, income-producing bonds that carry investment grade bond ratings. Speculators and distressed investors making a living off high-risk, high-reward opportunities could turn to non-investment grade bonds for speculative opportunities.

RELATED TERMS
  1. Bond Rating Agencies

    Companies that assess the creditworthiness of both debt securities ...
  2. Bond

    A debt investment in which an investor loans money to an entity ...
  3. Credit Quality

    One of the principal criteria for judging the investment quality ...
  4. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  5. Junk Bond

    A colloquial term for a high-yield or non-investment grade bond. ...
  6. Moody's Bond Survey

    A weekly publication that reports changes in corporate bond quality ...
Related Articles
  1. Investing

    Explaining Bond Ratings

    A bond rating is a grade given to a bond to indicate its creditworthiness.
  2. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  3. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  4. Investing

    Why Bad Bonds Get Good Ratings

    Credit ratings are not the only tool to rely on when assessing bonds. Find out why they sometimes fall short.
  5. Investing

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  6. Investing

    When To Trust Bond Rating Agencies

    Despite investor distrust, rating agencies can be helpful. Just be sure you use these ratings as a starting point.
  7. Investing

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
  8. Investing

    5 Basic Things To Know About Bonds

    Learn these basic terms to breakdown this seemingly complex investment area.
  9. Investing

    5 Reasons to Invest in Municipal Bonds When the Fed Hikes Rates

    Discover five reasons why investing in municipal bonds after the Fed hikes interest rates, and not before, can be a great way to boost investment income.
  10. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
RELATED FAQS
  1. What are the highest-yielding investment grade bonds?

    Learn how Standard & Poor's and Moody's rate bonds. Understand what investment grade bonds offer the best yield. Read Answer >>
  2. What are the risks of investing in a bond?

    The most well-known risk in the bond market is interest rate risk - the risk that bond prices will fall as interest rates ... Read Answer >>
  3. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
  4. What forms of debt security are available for the average investor?

    Discover the various different types of debt securities, issued by government entities or corporations, that are available ... Read Answer >>
  5. What are the biggest risks of fixed-income investing?

    Learn about the three biggest risks of bonds and other fixed-income investments. Find out more about related issues and learn ... Read Answer >>
Hot Definitions
  1. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  2. Life Insurance

    A protection against the loss of income that would result if the insured passed away. The named beneficiary receives the ...
  3. Price Elasticity Of Demand

    A measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. Price ...
  4. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  5. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  6. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
Trading Center