Credit ratings: what they assess and why they are not a guarantee
intermediate
Automated material · TradeAlmanac editorial deskPrepared by a language model from our stored data and checked by an editor.
A credit rating is an assessment of how likely an issuer is to meet its obligations. It is expressed on a letter scale and assigned by an agency.
What it gives
Fast sorting. The distance between the top and bottom of the scale corresponds to fundamentally different probabilities of trouble.
A reference for comparing yields: an issue's premium over a government bond of the same maturity should match its rating. A markedly larger premium at the same rating is a reason to investigate rather than to celebrate.
What it does not assess
Market risk: a rating says nothing about how the price will behave when rates change.
Liquidity: a highly rated issue can trade rarely.
The terms of the specific issue: put dates, amortisation and subordination all affect your result and are not reflected in the issuer's rating.
Subordinated issues
A separate case where a higher yield is explained not by the issuer's credit quality but by the ranking of claims. In trouble such bonds suffer first, and the write-off is sometimes total.
How to use it
As a filter at the entrance, not as a substitute for analysis. Beyond it, read the issuer's accounts and the structure of its debt: Leverage: how much debt is too much.
Related: OFZ and corporate bonds: what the premium pays for and Yield to maturity: the only honest number a bond has.
Prepared by a language model from our stored data and checked by an editor.
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