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Subject 2. Credit Rating Agencies and Credit Ratings PDF Download

Nearly every bond issue in developed debt markets carries credit ratings classifying creditworthiness. The rating agencies (Moody's, S&P, and Fitch) rate both issuers and issues.

  • Issuer ratings are meant to address an issuer's overall creditworthiness - its risk of default.
  • Ratings for issues incorporate such factors as rankings in the capital structure.

Credit ratings enable comparisons of the credit risk of debt issues and issuers within and across industries.

The three major global credit rating agencies (Moody's, S&P and Fitch) use similar, symbol-based ratings that assess a bond issuer's risk of default and the potential loss the investor may suffer.

  • Bonds rated Baa3/BBB- or higher are called "investment grade".
  • Non-investment-grade or high-yield bonds: BB+ or lower/Ba1 or less. They represent substantial to very high credit risk.

Risks in Relying on Agency Ratings

There are risks in relying too much on credit agency ratings.

  • Because creditworthiness is dynamic, initial/current ratings do not necessarily reflect the evolution of credit quality over an investor's holding period. Importantly, bond ratings do not always capture price risk because valuations often adjust before ratings change and the notching process may not adequately reflect the price decline of a bond that is lower ranked in the capital structure.

  • Some risks are difficult to capture in credit ratings. Like analysts, credit rating agencies may have difficulty forecasting certain credit-negative outcomes, such as adverse litigation, leveraging corporate transactions, and such low likelihood/high severity events as earthquakes and hurricanes.

  • Ratings may involve miscalculations. Unforeseen changes may not be fully captured in a rating agency's forward-looking analysis.

User Contributed Comments 3

User Comment
johntan1979 From previous module: credit spread widens before a downgrade.
HolzGe1 The notes dont mention the rating agency gets paid by the issuer, so they're about as "independent" as the company's auditor :S

Gotta love financial markets!
cfaguy promote capital market integrity, it's the same as asking non-believer to worship, but different fields "Khalifa."
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I am using your study notes and I know of at least 5 other friends of mine who used it and passed the exam last Dec. Keep up your great work!
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