Glossary term
Credit Rating
A credit rating is an opinion about the creditworthiness of a bond, issuer, company, or government, usually expressed as a letter grade by a credit rating agency.
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What Is a Credit Rating?
A credit rating is an opinion about the creditworthiness of a bond, issuer, company, or government. It is usually expressed as a letter grade by a credit rating agency and is meant to estimate relative credit risk, or the risk that the borrower will not meet its debt obligations as promised.
Credit ratings are common in bond investing. They can help investors compare credit risk, but they are not guarantees, investment advice, or complete measures of risk.
Key Takeaways
- Credit ratings estimate credit risk and creditworthiness.
- They are often shown as letter grades such as AAA, BBB, BB, or lower.
- Investment-grade ratings generally indicate lower credit risk than non-investment-grade ratings.
- Ratings can change without warning.
- A credit rating does not measure every risk, including interest-rate risk, liquidity risk, or price risk.
How Credit Ratings Work
Credit rating agencies review issuers and debt securities using their own methods, assumptions, and rating scales. The rating reflects the agency's opinion about the likelihood that the issuer or debt instrument will meet its financial obligations.
Higher ratings generally suggest lower expected default risk. Lower ratings suggest higher credit risk and often require higher yields to attract investors. The exact meaning of a symbol depends on the rating agency's scale.
Investment Grade Versus Non-Investment Grade
Many rating scales separate investment-grade bonds from non-investment-grade bonds. Investment-grade ratings generally begin around BBB- or Baa3, depending on the agency. Ratings below that level are often called high-yield, speculative-grade, or non-investment-grade.
Rating category | General interpretation |
|---|---|
Investment grade | Lower relative credit risk |
Non-investment grade | Higher relative credit risk and usually higher required yield |
This line is useful, but it is not magic. A bond can be rated investment grade and still lose value or default. A lower-rated bond can also perform well if the issuer improves or the price already reflects the risk.
What Credit Ratings Do Not Tell You
A credit rating does not tell investors whether a bond is fairly priced. It does not measure how much the bond may fall if interest rates rise. It does not guarantee liquidity. It also does not mean the rating agency, the issuer, or the SEC recommends the bond.
Ratings are one input. Investors still need to review yield, maturity, call features, seniority, issuer financials, bond documents, and portfolio fit.
Why Credit Ratings Matter
Credit ratings influence bond yields, borrowing costs, portfolio guidelines, and risk controls. Some funds or institutions may only buy bonds above a certain rating. If a bond is downgraded, its price can fall because investors demand more compensation for the perceived risk.
Ratings also help investors screen large bond markets. They make credit risk easier to sort, but not simple enough to outsource judgment entirely.
The Bottom Line
A credit rating is an opinion about creditworthiness, usually shown as a letter grade. It can help investors interpret default risk, but it should be used alongside price, yield, bond terms, issuer fundamentals, and other risks.