Complete Guide To Corporate Finance


Bonds - Bond Ratings

A bond rating is a grade given to a bond that indicates its credit quality. Private independent rating services provide these evaluations of a bond issuer's financial strength or its ability to pay a bond's principal and interest in a timely fashion. Bond ratings are expressed as letters ranging from "AAA," which is the highest grade, to "C" or "D" ("junk"), which is the lowest grade. Different rating services use the same letter grades, but use various combinations of upper and lower-case letters to differentiate themselves.

The bond rating system helps investors determine a company's credit risk. Think of a bond rating as the report card for a company's credit rating. Blue-chip firms, which are safer investments, have a high rating, while risky companies have a low rating. The chart below illustrates the different bond rating scales from the major rating agencies in the United States: Moody's, Standard and Poor's and Fitch Ratings.

Bond Rating
S&P/ Fitch
Highest Quality
High Quality
Medium Grade
Ba, B
Highly Speculative
In Default

Notice that if the company falls below a certain credit rating, its grade changes from investment quality to junk status. Junk bonds are aptly named: they are the debt of companies in some sort of financial difficulty. Because these bonds are so risky, they have to offer much higher yields than any other debt. Bonds are not inherently safer than stocks. Certain types of bonds can be just as risky, if not riskier, than stocks.

Rating the creditworthiness of a bond issuer, despite the number crunching, is as much an art form as it is a science. While companies like Moody's and A.M. Best gather and analyze mountains of data, the rating itself comes down to the informed opinion of an analyst or a rating committee.

The organizations that rate bonds look at an issuer's assets, debts, income, expenses and financial history. In addition, they give special attention to the trustworthiness of a company to repay previous bond issues on time and in full.

Rating agencies regularly review bond ratings every six to 12 months. However, a bond may be reviewed at any time the agency deems necessary for reasons including missed or delayed payments to investors, issuance of new bonds, changes to an issuer's underlying financial fundamentals, or other broad economic developments. (For more on this subject, read The Debt Ratings Debate.)

Institutional and individual investors rely on bond rating agencies and their in-depth research to make investment decisions. Rating agencies play an integral role in the investment process and can make or break a company's success in both the primary and secondary bond markets. While the rating agencies provide a robust service and are worth the fees they earn, the value of such ratings has been widely questioned since the 2008 financial crisis, and the agencies' timing and opinions have been criticized when dramatic downgrades have come very quickly.

Investors should not rely solely on the bond rating agency's rating and should supplement the ratings with their own research. It's also important to frequently review the ratings over the life of a bond. (Read more in Bond Rating Agencies: Can You Trust Them? and Why Bad Bonds Get Good Ratings.)

Occasionally, firms will not have their bonds rated, in which case it is solely up to the investor to judge a firm's repayment ability. Because the rating systems differ for each agency and change from time to time, it is prudent to research the rating definition for the bond issue you are considering.

The Bond Market
Related Articles
  1. Investing Basics

    What Does In Specie Mean?

    In specie describes the distribution of an asset in its physical form instead of cash.
  2. Economics

    Calculating Days Working Capital

    A company’s days working capital ratio shows how many days it takes to convert working capital into revenue.
  3. Economics

    Calculating Cross Elasticity of Demand

    Cross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
  4. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  5. Professionals

    Career Advice: Accountant Vs. Controller

    Learn about the differences between controllers and accountants, how the two are related and which is the best career choice for aspiring bookkeepers.
  6. Professionals

    What is Cash Basis Accounting?

    Cash basis accounting recognizes revenues and expenses at the time cash is paid or received.
  7. Entrepreneurship

    What's a Good Profit Margin for a Mature Business?

    How to determine if the amount you clear dovetails with the competition.
  8. Fundamental Analysis

    Emerging Markets: Analyzing Chile's GDP

    Chile has become one of the great economic success stories of Latin America.
  9. Investing

    Watch Your Duration When Rates Rise

    While recent market volatility is leading investors to look for the nearest exit, here are some suggestions for bond exposure in attractive sectors.
  10. Economics

    Understanding Explicit Costs

    Common examples of explicit costs include wages, utilities, rent, raw materials, and other direct expenses companies pay to conduct business.
  1. Put-Call Parity

    A principle that defines the relationship between the price of ...
  2. Encumbrance

    A claim against a property by a party that is not the owner. ...
  3. Alpha

    Alpha is used in finance to represent two things: 1. a measure ...
  4. Capitalization Rate

    The rate of return on a real estate investment property based ...
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
  6. Linear Relationship

    A statistical term used to describe the directly proportional ...
  1. What should I study in school to prepare for a career in corporate finance?

    Depending on which area you want to specialize in, corporate finance can be one of the most competitive fields in business. ... Read Full Answer >>
  2. Why would a company issue preference shares instead of common shares?

    Preference shares, or preferred stock, act as a hybrid between common shares and bond issues. As with any produced good or ... Read Full Answer >>
  3. What is the difference between cost of debt capital and cost of equity?

    In corporate finance, capital – the money a business uses to fund operations – comes from two sources: debt and equity. While ... Read Full Answer >>
  4. What is the difference between gross profit, operating profit and net income?

    The terms profit and income are often used interchangeably in day-to-day life. In corporate finance, however, these terms ... Read Full Answer >>
  5. Student loans, federal and private: what's the difference?

    The cost of a college education now rivals many home prices, making student loans a huge debt that many young people face ... Read Full Answer >>
  6. What is a profit and loss (P&L) statement and why do companies publish them?

    A profit and loss (P&L) statement, or balance sheet, is essentially a snapshot of a company's financial activity for ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!