Rating agencies (bond rating services)

Definition

Rating agencies (bond rating services) are organizations that assess the creditworthiness of issuers of bonds and assign ratings that reflect the likelihood of default. These ratings help investors evaluate the risk associated with investing in a particular bond.

5 Must Know Facts For Your Next Test

1. Rating agencies such as Moody's, Standard & Poor's, and Fitch are the most prominent in evaluating bond creditworthiness.
2. Bond ratings range from high-grade (AAA) to low-grade or 'junk' status (below BBB), indicating varying levels of risk.
3. A higher bond rating generally leads to lower interest rates for issuers because it signifies lower risk to investors.
4. Rating agencies periodically review and may adjust their ratings based on changes in an issuer’s financial health or economic conditions.
5. The methodology used by rating agencies includes analyzing factors like cash flow, debt levels, economic environment, and management quality.

Review Questions

• What are the primary functions of rating agencies in the bond market?
• How do bond ratings affect an issuer's interest rates?
• What factors might cause a rating agency to adjust a bond's rating?

Related terms

Credit Risk: The possibility that a bond issuer will default on its payments.

Interest Rate Risk: The risk that changes in market interest rates will affect the value of bonds.

Default: The failure to meet the legal obligations or conditions of a loan agreement.