A:

Credit ratings provide a useful measure for comparing fixed-income securities, such as bonds, bills and notes. Most companies are issued a rating based on their financial strength, future prospects and past history. Companies that have manageable levels of debt, good earnings potential and a good debt-paying records will have good credit ratings.

Investment grade refers to the quality of a company's credit. In order to be considered an investment grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's. Anything below this 'BBB' rating is considered non-investment grade. If the company or bond is rated 'BB' or lower it is known as junk grade, in which case the probability that the company will repay its issued debt is deemed to be speculative.

Any time that you purchase or sell bonds, bills or notes, they will have an associated credit rating. This rating changes over time as the company's strength and debt load changes. If a company takes on more debt than it can handle or if its earnings outlook weakens, the company's rating will be lowered. If it reduces its debt or finds a way to increase potential earnings, the company's rating will usually increase.

To read more on this topic, see What Is A Corporate Credit Rating and Junk Bonds: Everything You Need To Know and Are High Yield Bonds Too Risky?

Which Securities Are Considered Investment Grade?

In finance, government and private fixed income securities, such as bonds and notes, are considered investment grade if they have a low risk of default. Investment grade is determined based on a relative scale by credit rating agencies such as Standard & Poor's and Moody's. Such credit ratings express the ability and willingness of a borrowing organization to repay its debt and are based on many financial and economic indicators that influence the borrower's creditworthiness. Securities with a rating of BBB or above from Standard and Poor's or Baa3 or above from Moody's are considered investment grade.

Credit ratings represent forward-looking statements about the creditworthiness and credit risk of a particular organization in meeting its financial obligations. The credit ratings give an indication of a default risk for an individual debt, a municipal bond, a government bond or mortgage-backed securities (MBS).

When constructing its rating, the credit rating agency takes into account a myriad of factors to come up with a well-balanced view of credit risk. Leverage, cash flows, earnings, interest coverage ratio and other financial ratios are common indicators that the credit rating agency considers to assign an investment grade to a specific security.

A security has an investment grade rating if it has a rating that falls within the range of Aaa to Baa3 from Moody's or AAA to BBB- for Standard & Poor's. The company's securities have investment grade ratings if it has a strong capacity to meet its financial commitments.

The rating of BBB- from Standard & Poor's and Baa3 from Moody's represents the lowest possible ratings for a security to be considered investment grade. BBB- and Baa3 ratings indicate that the company that issued such securities has an adequate capacity to meet its obligations, but it can be subject to adverse economic conditions and changes in financial circumstances.

It is common for a security to lose its investment grade rating. The reasons for such events vary and can be related to changes in the overall business environment such as recession, industry-specific problems or the company's own financial problems.

If there is a recession, it is likely that many companies are struggling to generate enough cash flow to cover their interest and principal repayments, and credit agencies can lower the rating of companies across sectors. A change in technology or the emergence of a rival within an industry can also warrant downgrades of securities rating from investment grade to speculative grade. Another common reason for the loss of a security's investment grade is due to the company's own problems, such as taking too much leverage, problems with collecting on accounts receivable and regulatory changes.

The rankings from credit ratings agencies should be taken with caution. During the financial crisis of 2007-08, it became evident that credit rating agencies misled the public by giving AAA rating to highly complex mortgage-backed securities market. It turned out that these MBS were high risk investments and their ratings were soon downgraded to speculative grade from investment grade.

RELATED FAQS
  1. How can I tell if a security is considered investment grade?

    Understand how Standard & Poor's and Moody's rates securities. Learn what types of ratings types go into evaluating the investment ... Read Answer >>
  2. How are bonds rated?

    Moody's, Standard and Poor's, Fitch Rating and Dominion Bond Rating Service are some of the internationally well-known bond ... Read Answer >>
  3. What can cause a security to go from investment grade to "junk" grade?

    Learn why bonds may be downgraded from investment grade to junk grade, and what impact this can have on the bond's price ... Read Answer >>
  4. How important is credit rating on a fixed income security?

    Learn how credit ratings for fixed-income securities impact the yield and provide guidance for the amount of risk for the ... Read Answer >>
Related Articles
  1. Investing

    What does Investment Grade Mean?

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

    Explaining Bond Ratings

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

    The Debt Ratings Debate

    Lack of competition and potential conflicts of interest have called the value of these ratings into question.
  4. Financial Advisor

    Top 5 Corporate Bond Mutual Funds (DEECX, FCBFX)

    Learn about the top five mutual funds that invest in corporate bonds that have investment grade quality and speculative credit ratings.
  5. Insights

    Does A Junk Rating Reflect Russia's Fundamentals?

    Moody’s, like other credit rating agencies, has downgraded Russia’s sovereign debt rating to non-investment grade, but does this reflect Russia's economy?
  6. Investing

    What Is the Value of a AAA Credit Rating? (XOM)

    Following the Exxon credit rating downgrade, investor's are asking is there any value in even having a AAA credit rating?
  7. Financial Advisor

    Advising FAs: Explaining Bonds to a Client

    Most 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 ...
  8. Investing

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  9. Financial Advisor

    Rising Rates: What It'll Mean for Stocks and Bonds

    A look at what rising interest rates could mean for the equity and bond markets.
  10. Investing

    The Appeal of Crossover Bonds

    Bonds that tend to cross from junk to investment-grade status, or the other way around, can provide interesting investment opportunities. Here's a look,
RELATED TERMS
  1. Investment Grade

    A rating that indicates that a municipal or corporate bond has ...
  2. A-Credit

    The highest credit grade available as assigned to a borrower ...
  3. Default Risk

    The event in which companies or individuals will be unable to ...
  4. Corporate Credit Rating

    The opinion of an independent agency regarding the likelihood ...
  5. Credit Quality

    Credit quality is one of the principal criteria for judging the ...
  6. Grading Certificate

    A document issued by inspectors or an approved grading panel ...
Hot Definitions
  1. Earnings Per Share - EPS

    Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock.
  2. Trustee

    A person or firm that holds or administers property or assets for the benefit of a third party. A trustee may be appointed ...
  3. Gross Domestic Product - GDP

    GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  4. Debt/Equity Ratio

    The D/E ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity.
  5. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  6. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
Trading Center