It is an assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities.
Credit is important since individuals and corporations with poor credit will have difficulty finding financing, and will most likely have to pay more due to the risk of default.
Before you decide whether to invest into a debt security from a company or foreign country, you must determine whether the prospective entity will be able to meet its obligations. A rating company can help you do this. Providing independent objective assessments of the credit worthiness of companies and countries, a credit rating company helps investors decide how risky it is to invest money in a certain country and / or security.
Credit in the Investment World:
As investment opportunities become more global and diverse, it is difficult to decide not only which companies but also which countries are good investment opportunities. There are advantages to investing in foreign markets, but the risks associated with sending money abroad are considerably higher than those associated with investing in your own domestic market. (For more insight, see Pros and Cons of Offshore Investing). It is important to gain insight into different investment environments but also to understand the risks and advantages these environments pose. Measuring the ability and willingness of an entity which could be a person, corporation, a security or a country to keep its financial commitments or its debt. Credit ratings are essential tools for helping you make some investment decisions.
There are three top agencies that deal in credit ratings for the investment world. These are: Moody’s, Standard and Poor’s (S&P’s) and Fitch IBCA. Each of these agencies aims to provide a rating system to help investors determine the risk associated with investing in a specific company, investing instruments or market.
Ratings can be assigned to short term and long term debt obligations as well as securities, loans, preferred stock and insurance companies. Long term credit ratings tend to be more indicative of a country’s investment surroundings and/or a company’s ability to honor its debt responsibilities.
For a government or company it is sometimes easier to pay back local-currency obligations than it is to pay foreign currency obligations. The ratings therefore assess an entity’s ability to pay debts in both foreign and local currencies. A lack of foreign reserves, for example, may warrant a lower rating for those obligations a country made in foreign currency.
It is important to note that ratings are not equal to or the same as buy, sell or hold recommendations. Ratings are rather a measure of an entity’s ability and willingness to repay debt.
The ratings are in:
The ratings lie on a spectrum ranging between highest credit quality on one and default or Junk on the other. Long term credit ratings are demoted with a letter: a triple A (AAA) is the highest credit quality, and C and D (depending on the agency issuing the rating) is the lowest or junk quality. Within this spectrum there are different degrees of each rating, which are, depending on the agency, sometimes denoted by a plus or negative sign or a number.
Thus, for Fitch IBCA, a “AAA” rating signifies the highest investment grade and means that there is very low credit risk. “AA” represents very high credit quality. “A” means high credit quality, and “BBB” is good credit quality. These ratings are considered to be investment grade, which means that the security or the entity being rated carries a level of quality that many institutions require when considering overseas investments.
Ratings that fall under “BBB” are considered to be speculative or Junk. Thus for Moody’s a Ba2 would be a speculative grade rating for S&Ps, a “D” denotes default of junk bond status.
Here is a chart that gives an overview of the different ratings symbols that Moody’s and Standard and Poor’s issue:
Moody’s Standard Poor’s & Grade Risk
Aaa AAA Investment Lowest Risk
Aa AA Investment Low Risk
A A Investment Low Risk
Baa BBB Investment Medium Risk
Ba, B BB, B Junk High Risk
Caa/Ca/C CCC/CC/C Junk Highest Risk
C D Junk In Default