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How Bond Ratings Work

Trade bonds free for 60 days using TD Ameritrade: http://bit.ly/td-ameritrade Join us in the discussion on InformedTrades: http://www.informedtrades.com/2005065... KEY POINTS 1. Bond ratings are a way to assess the default risk of a bond. Default risk is the risk that the bond issuer will not be able to pay back the full coupon and principal obligations of the bond they issued. 2. There are three agencies that collectively account for 90% of the market for credit ratings: Standard & Poor's, Moody's, and Fitch Ratings. Of the three, S&P and Moody's account for 40% each; Fitch is a minority player whose primarily role is to serve as the tie-breaker of sorts when S&P and Moody's issue conflicting ratings. 3. A bond is considered investment grade or IG if its credit rating is BBB- or higher by Standard & Poor's or Baa3 or higher by Moody's. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them. A bond's yield is typically inversely related to its rating; in other words, bonds with lower ratings have higher yields. 4. Bond rating agencies have come under considerable criticism in the years since the financial crisis of 2008. Agencies collectively failed to identify credit securities that were at high default risk, and have been sued for their actions. That agencies derive their revenue from governments and corporations that pay them for ratings has also led many to question their integrity and objectivity. 5. In spite of the increase in skepticism regarding the objectivity and competence of the credit ratings agencies, changes in bond ratings can and do impact bond prices, often considerably. As such, investors may wish to factor in ratings into their analysis and portfolio decisions using bond screeners.