Credit Ratings.
In plain English
Credit ratings are letter grades assigned by agencies such as Moody's, S&P, and Fitch that estimate the chance a bond issuer will repay its debt. The grades run from very safe (like AAA) down to very risky, with a dividing line between investment grade (safer) and high-yield or junk (riskier). A higher rating usually means the issuer can borrow at a lower interest rate, because lenders feel safer. The ratings are opinions, not guarantees, and they can be lowered or raised as the issuer's finances change.
01Why it matters
A bond's rating is a quick signal of how much risk you are taking for the interest you earn, and a downgrade can knock down the price of a bond you already own.
02The math, step by step
Imagine two companies each issue a 10-year bond. The one rated AAA might pay 4 percent interest because lenders trust it, while the one rated BB (below investment grade) might have to pay 7 percent to attract buyers. You earn more from the BB bond, but you are accepting a higher chance the company misses payments. If the AAA company later gets downgraded to A, the market price of its existing bonds usually falls.
03What this is NOT
A bond credit rating is NOT your FICO score. Credit ratings grade large borrowers like companies and governments and use letter scales from agencies. Your personal credit score is a number that lenders use to judge you as an individual.
04Receipts
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Plain-English answers from our glossary. Receipts included. Never advice.
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