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 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

    Bond rating agencies are companies that assess the creditworthiness ...
  2. AAA

    AAA is the highest possible rating assigned to the bonds of an ...
  3. Bond Yield

    Bond yield is the amount of return an investor will realize on ...
  4. Junk Bond

    A colloquial term for a high-yield or non-investment grade bond. ...
  5. Agency Bond

    An agency bond is a bond issued by a government agency. These ...
  6. Corporate Bond

    A corporate bond is a debt security issued by a corporation and ...
Related Articles
  1. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  2. 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.
  3. 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.
  4. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  5. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  6. Investing

    Find the Right Bond at the Right Time

    Learn about the types of bonds you should consider investing in, when you should be buying them and how to compare yields against their time to maturity.
  7. Investing

    4 basic things to know about bonds

    Learn the basic lingo of bonds to unveil familiar market dynamics and open to the door to becoming a competent bond investor.
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center