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

    A debt investment in which an investor loans money to an entity ...
  2. Bond Rating Agencies

    Companies that assess the creditworthiness of both debt securities ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer ...
  4. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  5. Credit Quality

    One of the principal criteria for judging the investment quality ...
  6. Corporate Bond

    A debt security issued by a corporation and sold to investors. ...
Related Articles
  1. Investing

    Explaining Bond Ratings

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

    What does Investment Grade Mean?

    Investment grade is a term used to describe a favorable rating for corporate and municipal bonds.
  3. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  4. Investing

    An Introduction to Individual Bonds

    Individual bonds are better than bond funds and can be a key component to one’s investment strategy.
  5. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  6. 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.
  7. 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.
  8. Investing

    U.S. Corporate Bonds: The Last Safe Place to Make Money

    There aren't many other sources right now for relatively safe, steady income.
  9. Investing

    What's a High-Yield Bond?

    A high-yield bond is a bond issued by a company with a very low credit rating.
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 causes a bond's price to rise?

    Learn about factors that influence the price of a bond, such as interest rate changes, credit rating, yield and overall market ... Read Answer >>
  3. How safe are high yield bonds?

    Learn how high-yield bonds have a greater risk of default than investment grade bonds and why they offer higher amounts of ... Read Answer >>
  4. 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 >>
Hot Definitions
  1. Blue Chip

    A blue chip is a nationally recognized, well-established, and financially sound company.
  2. Payback Period

    The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
  3. Collateral Value

    The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...
  4. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  5. Current Account

    The difference between a nation’s savings and its investment. The current account is defined as the sum of goods and services ...
  6. Liability

    Liabilities are defined as a company's legal debts or obligations that arise during the course of business operations.
Trading Center