13.7 : Bond Ratings

Bond ratings assess the creditworthiness of a bond issuer, reflecting its ability to repay debt and meet financial obligations. Agencies like Moody's and Standard & Poor's (S&P) assess bonds based on the issuer's likelihood of default and the level of creditor protection in case of default.

Ratings range from AAA/Aaa, representing the highest credit quality and minimal risk, to D, indicating bonds in default. Investment-grade bonds rated BBB/Baa or higher are considered relatively safe and are preferred by conservative investors, such as pension funds and banks. Bonds rated below investment grade, commonly called junk bonds, carry higher risks but offer potentially more significant returns.

Disagreements between rating agencies can result in split ratings or crossover bonds, which fall between investment-grade and junk status. Credit ratings may also change over time based on the issuer's financial condition. For instance, bonds downgraded from investment-grade to junk are called fallen angels.

Bond ratings are useful for assessing default risk, but they do not consider the price volatility that can arise from changes in interest rates. Even bonds with high ratings can experience significant price fluctuations.

Understanding bond ratings is important for effectively managing risk and making informed investment decisions. While defaults are uncommon, they can lead to considerable losses for investors.